The change in quality of financial reporting after the mandatory implementation of IFRS in Europe : a literature review

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The Change in Quality of Financial Reporting after the

Mandatory Implementation of IFRS in Europe

A literature review

Salama Yasmina Alioua

Student number: 10799435 Date of submission: June 26 2018 Version: Final version BSc Accountancy & Control Amsterdam Business School, University of Amsterdam Supervisor: Dennis Jullens Word count: 10.609

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Statement of Originality

This document is written by student Salama Alioua who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in

creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

This thesis examines whether the reporting quality of firms in Europe has improved after the mandatory implementation of International Financial Reporting Standards (IFRS). After January 1 2005, every listed firm in the European Union is obliged to prepare their financial statements in accordance with these globally used accounting standards. The research question is answered by means of a literature review. Reporting quality is measured using the four enhancing qualitative characteristics the IASB has set; comparability, verifiability, timeliness and understandability. In addition to this, the dimensions of reporting quality, earnings management and value relevance, are added. The findings reveal mixed evidence about the impact of the mandatory implementation. The results indicate a positive relation between the IFRS implementation and reporting quality, thus implying an improvement in reporting quality after the implementation.

Samenvatting

In deze scriptie staat de relatie tussen de kwaliteit van financiële verslaggeving en de invoering van de International Financial Reporting Standards (IFRS) centraal. Er wordt onderzocht of de kwaliteit verbeterd is na verplichte implementatie van IFRS. Vanaf 1 januari 2005 is elk beursgenoteerd bedrijf in de Europese Unie verplicht de financiële verslaggeving op te stellen volgens deze wereldwijd gebruikte accounting standaarden. De onderzoeksvraag is beantwoord aan de hand van een

literatuuronderzoek. Financiële verslaggeving wordt gemeten met behulp van de vier verbeterende kwalitatieve kenmerken gesteld door de IASB; vergelijkbaarheid, verifieerbaarheid, tijdigheid en begrijpelijkheid. Ook worden de dimensies van kwaliteit van financiële verslaggeving getoetst, earnings management en value relevance. De resultaten tonen gemixte bewijzen over de impact van de implementatie van IFRS, echter kan er geconcludeerd worden dat er een positieve relatie bestaat tussen de IFRS-implementatie en rapportagekwaliteit. Dit impliceert een verbetering van de kwaliteit van financiële verslaggeving na de verplichte invoering van IFRS.

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Table of Figures

Figure 1: Conceptual Framework ... 14

Figure 2: Rules-based vs. Principles-based... 17

Figure 3: Earnings management ... 21

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Chapter 1: Introduction

On January 24 2017, The Telegraph reported that British Telecom suffered their worst day ever as a public company because of the exposure of an accounting scandal. BT Italy has allegedly been over-reporting earnings for years, which has never been brought to public attention by PwC, which was BT’s auditor for over 30 years. This is not the first or only accounting scandal that has been revealed the past decades. Similar scandals occurred at Enron (2001) and Ahold (2003) and they both caused a lot of disturbance, which resulted in a debate about the quality of financial reporting from companies. Besides this, a study from Blom (2009) showed that big accounting scandals have led to an increase in public interest in the quality of financial reporting from companies. Companies’ stakeholders base their investment decisions on the financial statements, so accounting scandals can cause them a considerable loss. The management of Enron intentionally misled their stakeholders for years by altering the financial statements, thus leading to a decrease in confidence of stakeholders in corporate management altogether (Van Beest, 2011). To re-establish the confidence of stakeholders and to respond to the recent accounting scandals, existing accounting standards were adjusted and new accounting standards were introduced. One of the changes entailed the introduction of the

International Financial Reporting Standards (IFRS). The IFRS were supposed to bring transparency,

accountability and efficiency to financial markets around the world (https://www.ifrs.org/). As from January 1 2005, it became mandatory for listed firms in the European Union, and Australia among others, to prepare their financial statements according to these standards (IFRS, 2016). The introduction of a homogenous accounting standard had to contribute to increased

comparability and transparency of financial reporting around the world (Ball, 2006). Objective of the

International Accounting Standards Board (IASB) was to develop a set of high quality,

understandable, enforceable and globally accepted financial reporting standards based upon clearly stated principles (IASPlus, 2015). These expectations assumed that the adoption of an internationally known accounting standard would lead to improvements in the quality of financial reporting, thus improving the quality of information presented to investors and other parties and subsequently enhancing the public trust in financial reporting.

Several countries, besides the European Union, have adopted the standards since the introduction in 2005; including Australia, Brazil and South Africa (PwC, 2015). Many proponents therefore believe that IFRS reporting is of higher quality than previous local General Accepted

Accounting Principles (GAAP) and that its adoption improves financial transparency, lowers

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capital for firms in countries that implemented IFRS (Levitt, 1998). With the implementation of IFRS, it would also be easier to interpret and implement than the previously used domestic accounting standards, consequently improving accounting quality (Chen et al, 2010). Chen et al. also reported increased earnings smoothing, decreased earnings management, an increase in accrual accounting and decreased timely loss recognition among the researched firms.

Barth et al. (2008) concluded in a general study that there is a relationship between the adherence of the IFRS and audit quality, where they found IFRS were associated with higher

accounting quality, because firms appeared to use less earnings management, a phenomenon that can best be described as the manipulation of earnings. As firms prefer reporting small profits to the reporting of losses, this can be seen as earnings management and thus lower reporting quality. Most countries applied their own national GAAP before switching to IFRS, so the impacts of the transition can vary by country. Accordingly, it is necessary to understand that the consequences of IFRS on accounting quality have become of significant importance for capital market participants and shareholders when a firm switches to IFRS.

The focus in recent research differs in nature of IFRS adoption, namely the distinction between mandatory and voluntary adoption. Before the introduction in 2005, firms were allowed to apply IFRS on their financial statements; firms were simply not required to yet. Every firm could initially choose to adopt IFRS voluntarily, so it is reasonable to assume that a firm would only choose to use IFRS when this was beneficial to their own financial reporting. Cuijpers and Buijink (2005) gave a reason for firms to switch to IFRS prior to the mandatory adoption in a study on the determinants of financial reporting choices. They reported that firms were expected to voluntarily adopt non-local standards, like IFRS, when the net benefits of switching from their local GAAP are positive. This way, they can provide their investors with additional information than is normally required, which can be seen as beneficial to external stakeholders.

Barth et al. (2008) based their research on the period when firms could still choose the voluntary adoption, so these findings can therefore be exposed to self-selection by firms adopting the new accounting standards in their own favor. Horton et al. (2012) reported that mandatory adoption has the potential to assist the process of cross-border comparability, increase transparency, decrease the cost of information and reduce information asymmetry. Hence, this should lead to an improvement in liquidity and competitiveness for firms and efficiency of markets (Ball, 2006). Besides this, Horton et al. (2012) stated that these assumptions were made on the supposition that mandatory IFRS

implementation provides superior information to stakeholders and increased accounting comparability, compared to previously used accounting standards.

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However, opponents claim mandatory implementation of IFRS will not necessarily solve the problem of comparability. Ball (2006) stated that a single set of standards, like IFRS, might not be suitable for all settings, given the differences between countries, and might therefore not improve value relevance and reliability. Furthermore, the costs associated with a transition from local GAAP to IFRS cannot be ignored, as they might be significant (Horton et al., 2012). Moreover, Van Beest (2011) suggested that the mandatory implementation could create more opportunities for earnings management by managers. IFRS leaves more room for professional judgement, which enables a higher subjectivity of managers.

Regarding this ongoing discussion, it is of significant importance that more research on mandatory implementation is conducted to demonstrate how mandatory implementation of IFRS has affected reporting quality.

Hence, this leads to the following research question:

How did the mandatory implementation of IFRS affect financial reporting quality in Europe?

As the use of discretion of earnings and the informativeness of earnings are difficult to measure, true economic performance like reporting quality is unobservable. Reporting quality is a broad concept with diversified dimensions (Burgstahler et al., 2006), which were not further

explained. However, previous research in international accounting has mostly focused on three main dimensions to measure the quality of financial reporting, namely the degree of earnings management, value relevance and timely loss recognition (Barth et al., 2008). To make it easier to compare the used methods and the findings to each other, the same variables are used in this thesis.

This thesis can be seen as a contribution to accounting research in a way that the three main dimensions of accounting quality are reviewed in one study, as they have not been combined in a study before. This thesis also includes the enhancing qualitative characteristics (comparability, verifiability, timeliness and understandability) of the IASB, further explained in chapter 2, to give a more detailed analysis of reporting quality. Lastly, this thesis contributes to prior literature by setting up suggestions and recommendations for further research.

Through a review of several studies in the literature, this thesis attempts to further research the relation between the adoption of IFRS and reporting quality. In order to answer the research question, as stated above, three sub-questions were drawn up.

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The remainder of this thesis is structured following the sub-questions. The second chapter contains the relevant theory and concepts behind IFRS, starting with IFRS and its background. Additionally, IFRS as a principles-based standard is compared to a rules-based standard and the distinction between mandatory and voluntary adoption is explained. This leads to the first sub-question:

1. What is IFRS and why were the IFRS first introduced?

In the third chapter, the concept of reporting quality is introduced. In order to link the term quality to financial reporting the three dimensions (earnings management, value relevance, timely loss

recognition) previously mentioned above are reviewed. The second sub-question is therefore as follows:

2. What is reporting quality?

The fourth chapter consists of an analysis based on prior research. A variation of studies are reviewed and their findings are compared to eventually answer the research question. Hence, the third sub-question is formulated as:

3. What does prior research say about the impact of IFRS on reporting quality?

In the fifth chapter, the main findings are discussed and subsequently a final conclusion is drawn based on the findings in the previous chapters. Finally, the limitations and implications of this thesis are discussed, where suggestions for future research are made.

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Chapter 2: What is IFRS and why were the IFRS first introduced?

This chapter describes the theory necessary to understand the discussion behind the research question. Firstly, the history of IFRS, its development over time and the convergence between IFRS and US GAAP is explained. Secondly, the Conceptual Framework of the IASB, the concept behind IFRS, is discussed. As previously mentioned in the introduction, a distinction between voluntary and

mandatory adoption of IFRS can be made. In order to understand how the specific choice of adoption can affect the quality of financial reporting, evidence for both options are considered. Lastly, IFRS as principles-based accounting standards are compared to rules-based accounting standards.

2.1. History behind IFRS

As previously mentioned in the introduction, to re-establish the confidence of stakeholders that was harmed through the exposure of several accounting scandals and to respond to those scandals, existing accounting standards were adjusted and new accounting standards were introduced. This was done in two ways. Firstly, in order to ensure the use of a global accounting standard worldwide, the US

Financial Accounting Standards Board (FASB) and the IASB signed the Norwalk Agreement, an

agreement to improve and converge IFRS and US GAAP (Van Beest, 2011). The IASB and FASB engaged in making sure that the existing financial reporting standards were fully compatible once brought into practice and that when the standards were launched, full compatibility remained the standard (Doupnik and Perera, 2007). From 2002, the FASB and IASB started various convergence projects to improve reporting quality worldwide, including the Conceptual Framework, which is explained in section 2.2. The Norwalk Agreement did not only establish the goal of developing compatible, high-quality accounting standards usable for domestic and cross-border financial reporting, it also established to develop standards jointly. This meant the development of joint standards, in order to eliminate narrow differences and to stay converged (FASB, 2006).

Secondly, on July 19, 2002 the European Parliament and the Council decided together how the implementation of IFRS should proceed (van Beest, 2011). This regulation demanded all listed

companies of member states in the European Union to draw up their financial reports in accordance with the International Financial Reporting Standards, as from January 2005. A listed firm is a firm that is listed on at least one stock exchange market, where its shares and other securities are being traded (Picker et al., 2013). At the same time, the IASB started improving the existing IAS standards and the issuance of new IFRS standards so that from that moment, IFRS referred to the new IFRS series issued by the IASB and the old IAS issued by the IASC (van Beest, 2011). The IASB is the

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successive organisation of the International Accounting Standards Committee (IASC), which initially issued international accounting standards. The IASC’s rules were named International Accounting

Standards (IAS). In contrast to the IASC, the IASB is better funded and staffed than the IASC and it

is more independent as well (Blom, 2009).

Since 2002, the FASB and IASB have been working together to improve and converge US GAAP and IFRS. In February 2006, both boards issued a Memorandum of Understanding describing the progress they hoped to achieve toward convergence by 2008. In this Memorandum, a specific new guideline was added, namely the aim to strive to develop new common standards that improve the quality of financial information, instead of trying to eliminate differences between standards (FASB, 2013). The Securities and Exchange Commission (SEC) have reported of indecisiveness, in its final report in July 2012, on whether to incorporate IFRS into the financial reporting system of the United States (FASB, 2013). The SEC examined various unresolved issues relating to the potential

incorporation of IFRS in the United States, including investor education and potential costs for companies to adopt and implement IFRS. The report left the discussion regarding a possible incorporation unresolved.

An example where the convergence of IFRS and US GAAP has recently been achieved, regards the revenue recognition in IFRS 15. On May 28, 2014 the FASB and IASB jointly issued a standard on the recognition of revenue. The standard provides enhancements to the quality and consistency of revenue recognition while also improving comparability in financial reporting of firms reporting under IFRS and US GAAP (FASB, 2014).

2.2. The Conceptual Framework

As a result of the convergence project from the FASB and the IASB, both boards decided to develop a new joint Conceptual Framework. The Framework was supposed to include the objectives of financial reporting and underlying qualitative characteristics (Van Beest et al., 2009). In 1989, the IASC issued the Framework for the Preparation and Presentation of Financial Statements, also known as the Framework (Picker et al., 2013). Thereafter, this framework was replaced in 2010 by the Conceptual

Framework for Financial Reporting, also known as the Conceptual Framework, which was issued by

the IASB.

The Conceptual Framework outlines the fundamental concepts for the preparation and

presentation of financial reporting, and thus forms the fundamentals of IFRS (IFRS, 2018). It ensures that the concept of the standards is consistent and that similar transactions are reported the same way, so as to provide useful information for investors, lenders and other creditors. Moreover, the

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Conceptual Framework offers assistance to preparers of financial statements in applying the accounting standards and coping with irregular cases, assistance to stakeholders to understand and interpret the standards as well as assistance to companies in developing accounting policies when no IFRS standard applies to a particular transaction (“Conceptual Framework for Financial Reporting”, 2018). The Conceptual Framework consists of four chapters:

In this thesis, only the first and third chapter are taken into account. In the first chapter, the objective of general purpose of financial reporting is stated. The objective of the IASB as formulated in the Conceptual Framework is as follows:

The IASB and the FASB argue together that it is possible to achieve this objective when financial statements are prepared from the firm’s perspective, not from the perspective of the firm’s investors. They state that therefore financial statements ought to focus on the firm’s resources and changes that occur due to a change in the resources, instead of focusing on the investors being the providers of the resources. Financial statements prepared from the perspective of the firm force the firm to have their own meaning, independent from the view of its investors. Additionally, the key users of financial statements are capital providers, including existing as well as potential new investors and lenders. The company acquires resources from these investors and lenders and therefore the capital providers have claims on those resources. By cause of these claims, capital providers are in need of the financial information from the firm.

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In the revised version of the Conceptual Framework, the IASB has shifted the focus of the financial statements towards the capital providers, rather than towards other users such as

governments, employees and regulatory bodies. Picker et al. (2013) stated that this should also aid in achieving the objective set by the IASB. However, before the objective can be met and fundamentally enforced, it is important to specify the characteristics of financial reporting.

Chen et al. (2010, p. 222) define accounting quality as “the extent to which financial statement

information reflects the underlying economic situation”. In other words, accounting quality is

displayed in financial statements. By connecting the objective of the IASB to the definition of accounting quality from Chen et al., it can be concluded that the quality of financial information is based on its usefulness. Whether information is useful depends on its relevance and its faithful representation, also called the fundamental qualitative characteristics (Picker et al., 2013). Financial information is relevant when it holds the potential to influence the decisions made by the information user, the capital providers in this case. Information is relevant when it has predictive or confirmatory value, or a combination of both. Predictive value relates to the potential to affect a user’s forecast about the future. Confirmatory value exists when the information is used as a feedback that either changes or confirms the past, or expectations based on the past. A faithful representation of financial information contains information that faithfully represents economic phenomena that are complete, neutral and free from error (IASB, 2010).

According to the IASB the degree of usefulness depends on enhancing qualitative characteristics, namely comparability, verifiability, timeliness and understandability. These characteristics are complementary to the fundamental characteristics mentioned above.

The enhancing characteristics make it possible to differentiate between useful information and less useful information. The aim of IASB is ultimately to increase usefulness of financial information by

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enhancing above characteristics through the implementation of IFRS, as illustrated in Figure 1 below. Through the explanation of the qualitative characteristics of the Conceptual Framework a more extensive understanding of the objectives will be achieved.

Figure 1: Conceptual Framework

2.3. Mandatory or voluntary adoption

As argued in the introduction, a difference in results exists due to the nature of the IFRS adoption, namely whether the implementation of IFRS is done voluntarily or mandatorily. In general, the effects of the mandatory IFRS implementation were smaller in comparison to those from voluntary adopters (Daske et al., 2008). They assign this difference to an increase in market liquidity, as voluntary adopters experience an overall improvement in liquidity and cost of capital around the time of the IFRS mandate, despite the adoption even before the mandate. Overall, they found a significant

improvement in liquidity for firms that implemented IFRS, before or after the mandate. The difference lies in the scope of the difference in liquidity due to the timing of the adoption. However, they state that the increase in liquidity cannot entirely be contributed to the nature of the implementation; it

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could be an indirect effect of implementing to IFRS in general. Daske et al. (2008) also argued that a firm that adopts IFRS voluntarily shows a more transparent attitude and it is possible that investors respond to the transparency in this attitude rather than to the adoption of IFRS. In their research, they mention several arguments as to why voluntary adopters could have experienced a more significant increase in liquidity. Firstly, the firms would benefit from the increased comparability between financial statements from firms that had to implement IFRS. Moreover, as early adopters mostly used both IFRS and their domestic accounting standards at the same time, this could have improved the quality of financial reporting (Daske et al., 2013). Nonetheless, the effect of the IFRS adoption on market liquidity and a firm’s cost of capital is less profound in countries where the quality of financial reporting and the audit is already reasonably high (Daske et al., 2008).

2.4. Principles-based vs. rules-based

The IFRS as outlined in the Conceptual Framework are more principles-based standards as opposed to rules-based standards (Carmona & Trombetta, 2008). A principles-based standard is based on

principles rather than strict rules and therefore exists of standards made in accordance with a

fundamental understanding of financial reporting. A rules-based standard generally consists of clear rules that specify every element of financial statements. Principles-based accounting is predominantly based on the fundamentals of accounting; decision usefulness, true and fair view, going concern and substance over form (Benston et al., 2006; Schipper, 2003). These principles form the fundamentals to which standard setters define additional rules to ensure the quality of financial reporting. By adding specifications, the standard becomes more rules-based (Nelson, 2003).

The shift from previously used national accounting standards to IFRS could therefore be seen as a transition from a rules-based standard to a more principles-based standard (van Beest, 2011). Van Beest argued that the main difference between the two standards lies in the concept of professional judgement. Professional judgement is allowed under a principles-based standard like IFRS, under a rules-based standard it is not. However, as it is possible that the previously used accounting standards from a country were already principles-based, the changes resulting from the transition are not as big as when changing from a rules-based standard. The discussion on principles-based and rules-based accounting standards continues due to the ongoing US debate on whether or not to adopt IFRS instead of the US Generally Accepted Accounting Principles (US GAAP) for their financial statements. This could potentially lead to the acceptance of more principles-based accounting standards globally.

A principle can be defined as a general statement which intent is to support truth and fairness and which serves as a guide to action for stakeholders (Institute of Chartered Accountants of Scotland,

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2006). Van Beest (2011) stated that principles-based standards are represented by the Conceptual Framework, implying that the concept of professional judgement reflects the importance of the qualitative characteristics of financial reporting. A principles-based standard serves to support reliability and a faithful representation of financial reporting and assists in the recognition of events and transactions.

One of the fundamentals of accounting represented in the Conceptual Framework is the

concept of ‘substance over form’. This principle is based on the true and fair view concept and implies that management is allowed to deviate from the accounting standard, only if this deviation improves the financial representation of the economic situation in the financial statements of a company (IASB, 1989). The true and fair view can be defined as the neutral view of economic reality, risks and benefits represented in the financial reports and therefore aid users in the decision-making process and the allocation of resources (IASB, 2008). When taking both concepts of the true and fair view and the substance over form into account, a conclusive definition of a principles-based standard can be made.

Van Beest (2011, p. 33) defines a principles-based standard as:

“A general description of the fundamental objectives of accounting, captured in a conceptual

framework to emphasize substance-over-form”.

Contrarily, he argued that rules-based standards are to be found on the other side of the continuum. The boundaries for financial reporting are determined by accounting standards, the standards provide the information on the definition, recognition, measurement, presentation and disclosure of an account (IASB, 1989). The reason that rules-based accounting standards are stated to be a continuum is

because standards start principles-based and become more rules-based by the addition of

requirements. Specific criteria, bright line thresholds, implementation guidance, exceptions and scope restrictions can define these requirements (Nelson, 2003). Contrary to principles-based standards, a rules-based standard consists of an extensive set of explicit details about what actions are permitted or not (Alexander & Jermkowich, 2006). Moreover, under rules-based accounting standards professional judgements are not permitted. Hence, rules-based standards are characterized as “form over

substance” (van Beest, 2011).

Van Beest (2011, p. 33) therefore defines a rules-based standard as:

“A system of financial reporting, which is based on detailed provisions of methods for most

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As stated above, the shift from previously used national GAAP to IFRS may result in a transition from a rules-based standard to a principles-based standard. This requires more professional judgement from managers and may thus result in a higher ability to manipulate earnings through judgement and hence lower the quality of financial reporting (Nelson, 2003). The following Figure 2 illustrates the different intermediary types of accounting standards. IFRS are located in the centre. This implies that IFRS are principles-based standards that contain an appropriate level of accounting rules, resulting in a mixture of moderate rules-based standards and principles-based standards.

Figure 2: Rules-based vs. Principles-based

Reprinted from “Rules-based and Principles-based Accounting Standards and Earnings

Management” Beest, 2011, p. 30

2.5. Conclusion

After the description of the various aspects necessary to fully comprehend the concept of IFRS, the first sub-question can be answered. To re-establish confidence of stakeholders harmed trough the exposure of several accounting scandals and in response to those scandals, existing accounting standards were adjusted and new accounting standards were introduced. Firstly, the FASB and the IASB singed the Norwalk Agreement to improve and convergence IFRS and US GAAP. Secondly, the IFRS were issued to ensure the quality of financial reporting as well as the comparability between financial reports. The regulation signed between the European Parliament and the Council demanded all listed firms of member states in the European Union to prepare their financial statements under IFRS, as from January 2005. This way, stakeholders are supposed to be better informed about the firm’s performance resulting in a higher quality of the financial reporting. The Conceptual Framework is created to form the basis for the underlying concepts of IFRS. It aids in preparing and presenting

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financial information conform to IFRS. The objective of financial statements is to provide financial information about the economic situation of the entity that is useful for all users. Moreover, the Conceptual Framework also provides qualitative characteristics of useful financial reporting, to be divided in fundamental qualities and enhancing qualities. The main topic in the third section is voluntary adoption versus mandatory adoption. Prior research stated that voluntary adopters experience a bigger improvement in liquidity and their cost of capital, as opposed to mandatory adopters. The shift to IFRS from a previously used national GAAP could be identified as a transition from a rules-based accounting standard towards a more principles-based standard. Principles-based accounting is based on the fundamental objectives of accounting, captured in the Conceptual Framework to emphasize the substance-over-form concept. Under principles-based standards, professional judgement from managers is permitted. Rules-based accounting contains strict and precise accounting rules that must be met, there is no room for professional judgement and this standard can therefore be characterized as form-over-substance.

The next chapter describes the concept of reporting quality to answer the second sub-question. Three dimensions that best measure reporting quality are illustrated and explained. These three

dimensions are earnings management, value relevance and timely loss recognition. For each of the three dimensions, definitions and background information are explained.

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Chapter 3: What is Reporting Quality?

In this chapter, the term quality is explained and linked to financial reporting in order to understand what is meant by accounting quality. Hoogendoorn and Mertens (2001, p. 406) describe quality in general sense as something that is compliant with expectations and requirements. This general description results in the concept that quality is related to the objective of financial reporting, namely providing its users in their need for information. This means that financial reporting is connected to the users for whom the statements are drawn up. They state that the main objective is to provide the users with truthful information by which they can assess the financial results and financial position of the firm. Good quality reporting serves to establish decision-making. Hoogendoorn and Mertens (2001) argue that there is a positive relation between the ability for users to form their opinion to take a decision and the quality of financial reporting. Regulations and reporting standards play an

important role here, as the reporting quality is dependent on the quality of accounting standards. As the economic situation of a firm cannot be observed, the majority of the studies done previously have focused on three main dimensions that operationalise this concept. These three

dimensions are the degree of earnings management, value relevance and timely loss recognition (Chen et al., 2010; Burghstahler et al., 2006; Barth et al., 2008). Both earnings management and timely loss recognition focus on earnings quality, whereas value relevance primarily focuses on accounting amounts.

3.1. Earnings management

In the related literature earnings management is often used as a proxy for earnings quality and can therefore influence reporting quality (Blom, 2009). In the following section, earnings management is defined and motives and incentives for managers to engage in earnings management are reviewed.

3.1.1. Background behind earnings management

As a result from significant research on the topic of earnings management, multiple definitions of earnings management have been made. As previously stated, all stakeholders of a company use financial reporting as a base for decision-making. It is therefore important for financial statements to be truthful and of high quality. Financial reporting also aids firms in distinguishing themselves from underperforming companies in the same economic environment and by facilitating efficient resource allocation (Healy & Wahlen, 1999).

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Not only do financial statements of a company reflect on the general performance of a company, managers can also use their knowledge to improve the effectiveness of the reported financial statements to interact with all stakeholders, including shareholders, lenders and creditors. The intention behind financial reporting is ultimately to facilitate investors into making better

investment decisions. Consequently, managers are in a position to exercise their judgement in various circumstances (Xiong, 2006). This judgement is required when choosing between different accounting methods for reporting a transaction. Among those appraisals are forming provisions for future

obligations like R&D expenditures, straight-line or accelerated depreciation methods or the LIFO, FIFO or weighted-average inventory valuation methods (Healy & Wahlen, 1999).

In other words, managers are able to use their own knowledge about the business and its opportunities to disclose valuable information that provides financial statements’ users with additional information about the expected future state of the firm (Scott, 1997). However, managers could also use this as a convenience to manage and manipulate financial statements in their favour. This way, managers choose reporting methods and estimations that do not correctly reflect the firms’ underlying position (Healy & Wahlen, 1999). This is the general view of the concept of earnings management, more specifically an intentional misstatement of earnings leading to figures and numbers that would have been different without any manipulation (Mohanram, 2003).

3.1.2. Earnings management definition

As previously declared, for the reason that there has already been done significant research on the topic of earnings management, numerous definitions of earnings management exist. According to Ronen and Yaari (2008) these definitions can be placed in three categories, namely white, grey or black. See Figure 3 below for a representation. White earnings management can be described as a beneficial form that improves the transparency of statements, black includes direct misrepresentations and can be called fraud. Grey could either be opportunistic or efficiency enhancing, this is

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Figure 3: Earnings management

Reprinted from: “Earnings Management” Ronen & Yaari, 2008, p. 25

The distinction in the three categories helps assess the possible nature of earnings management and whether the choice for a specific accounting method is economically opportunistic or efficient. The most common way that earnings management is interpreted in literature can be based on two different definitions, by Schipper (1989) and by Ronen & Yaari (2008).

The general conclusion from these two definitions is that earnings management can be described as a purposeful intervention in the external financial reporting process by managers, to alter the financial reports to either mislead stakeholders about the economic situation of the company, or influence contractual outcomes that are dependent on these numbers.

Healy and Wahlen (1999) emphasize that a manager’s professional judgement in financial reporting has both the potential costs and benefits. The potential costs contain the misallocation of resources that result from earnings management. The benefits consist of the potential enhancements in the information provided by managers to stakeholders, improving the allocation of resource decisions. According to Schipper’s definition, earnings management is also used to manipulate stakeholders, but

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misleading stakeholders is not a form of fraud. Fraud is only the case when stakeholders are misled in a way that is prohibited by regulations. Subsequently, earnings management is legal as long as

financial statements are in accordance with the rules established by the IASB. Both Healy & Wahlen and Schipper define earnings management as manipulation, but not as illegal and thus within the boundaries of regulations.

3.1.3. Earnings management incentives

Regardless of the public wisdom of the existence of earnings management, it has been difficult for researchers to document it. To identify whether a company has engaged in earnings management, the first step is to assess the earnings before potential effects of earnings management. To solve this particular problem, it is important to classify the specific conditions in which managers’ incentives to manage earnings are likely to be strong (Healy & Wahlen, 1999). Mainly because earnings

management is a managerial activity, it is driven by managers’ incentives (Stolowy and Breton, 2004). These incentives can be separated into two groups, where one group is based on the positive theory which focuses on a firm’s internal contractual incentive (Xiong, 2006). The second group consists of capital market incentives, which are based on the way investors and analysts use accounting

information. According to Healy and Wahlen (1999), three main categories of incentives for which managers resort to earnings management can be recognised. These categories are capital market expectations, compensation contract motivations and regulatory motivations. The following paragraph includes a description of these incentives based on previous research.

3.1.3.1. Capital market expectations

According to Yanqiong (2010), capital market expectations are considered the main reason for

managers to engage in earnings management. Investors and analysts use the numbers and figures from financial statements to value the firm’s stock price. This can create an incentive for managers to manipulate the numbers in order to influence the stock price performance (Healy & Wahlen, 1999). As earnings provide useful information for investment decisions, managers who are monitored by investors, analysts, customers and suppliers acting in self-interest, or sometimes acting on behalf of shareholders, have strong incentives to manage earnings (Blom, 2009).

3.1.3.2. Compensation contract motivations

Managers usually are compensated based on compensation contracts. There are both explicit as well as implicit compensation, to align with the objectives of internal management and external

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income and sales rates are observed by requiring accounting data (Yanqiong, 2010). The accounting data is applied to determine the contractual compensation for managers and since the contracts are based on the success rates represented in the accounting data, managers may have an incentive to manipulate the data by engaging in earnings management to meet the contract requirements (Blom, 2009). These contracts may give an extra opportunity to engage in earnings management, because it is expensive for creditors to observe and detect earnings management, as found in a study by Watt and Zimmerman (1978).

3.1.3.3. Regulatory motivations

In the daily process, firms are.involved.with.external.agreements.such as dividend covenants, supply contracts and debt contracts (Yanqiong, 2010). As accounting data is used for external agreements, an incentive for managers may be to manage earnings in order to meet the contractual requirements. A study by Xiong (2006) found that firms are restricted by their creditors on certain activities, such as share repurchases, dividend payments and on taking additional loans, in order to ensure to repayment of principle and interest. These restrictions can be found in ratios or other specific accounting

numbers, which gives managers exact benchmarks that need to be met to satisfy the requirements. On the contrary, Sweeney (1994) stated that earnings management does not particularly occur to avoid the violation of debt covenants, but mostly after violation has occurred to reduce the possibility of future contractual violations.

3.2. Value relevance

The second dimension that is examined in this thesis is value relevance. This concept entails an indication of the relevance and reliability of the accounting amounts (Barth et al., 2001). Research on value relevance determines how well accounting amounts display information used by investors and provides insights on questions to standard setters. According to the existing literature on this matter, an accounting matter is defined as value relevant if it shows the anticipated association with the market values.

The FASB (1984) state that the relevance of an accounting amount is associated with its ability of making a difference to decisions made by financial statement users. In addition, an accounting amount is considered reliable if it represents what it claims to represent in the financial statements. Accounting amounts used for this purpose have a close relation to the economic concept of profit, such as returns and book value of equity. The higher the association between share price and returns, the higher the accounting quality of the firm (Barth et al., 2008). A practical explanation to this is that

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this way, the accounting data better explains the price of the stock. An earlier study of Barth et al. (2001) adds to this by declaring that a higher accounting quality means that the accounting information better reflects the underlying economic performance of the firm.

3.3. Timely loss recognition

The concept of timely loss recognition is the last dimension of reporting quality analysed in this thesis. Timely loss recognition contains the concept of timeliness of recognizing a loss by firms (Barth et al., 2008). Ball (2006) declares that the recognition of large losses when they occur instead of the losses being deferred to later periods indicates on higher accounting quality. As discussed in the previous chapter, managers have incentives to enhance their own performance measures by increasing net income. By deferring the recognition of large losses, a manager can report higher net income in the current period. Therefore, the timely recognition of losses is considered as higher accounting quality, as this more accurately reflects the underlying economic performance of the firm (Barth et al., 2008). To assess and interpret the impact of IFRS on accounting quality, timely loss recognition before and after the adoption of IFRS is observed.

3.4. Conclusion

In this chapter, reporting quality is examined by three of its dimensions, namely the degree of earnings management, timely loss recognition and value relevance. For the reason that earnings management is the most commonly used proxy for earnings quality, it is outlined in more detail. Earnings

management is generally known as the purposeful intervention by managers to alter the financial statements in order to mislead stakeholders about the firm’s economic situation or to influence contractual outcome based on these numbers. A manager’s motivation to engage in earnings management can come from various incentives. The first incentive described in this thesis is an incentive arising from capital market expectations. Managers may influence the stock price performance in order to meet analysts’ forecasts. Secondly, compensation contracts may drive managers to manipulate data to maximise their own benefits. Lastly, managers are obliged to meet specific contractual requirements and in order to meet the requirements they may engage in earnings management. After earnings management, the concept of value relevance is examined. This

dimension explains the relation between share prices and accounting amounts. A higher association between these two measures predicts a higher quality of reporting. Subsequently, timely loss

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net income in a current period. Stated is that the deferral of recognition is perceived as lower quality of financial reporting.

The next chapter consists of an analysis of prior research done on the topic of mandatory IFRS implementation.

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Chapter 4: What does prior research say about the impact of the

mandatory IFRS implementation?

In this chapter, previous research on the topic of mandatory IFRS implementation is reviewed. A variety of studies followed the same approach in evaluating the change in financial reporting quality after the mandatory implementation of IFRS, thus enabling to compare between the findings. As stated before, as a scientific contribution to prior research the enhancing qualitative characteristics comparability, verifiability, timeliness and understandability are added to this thesis. A comparison is made based on the requirements the IASB sets for financial reporting to be of high quality, the

qualitative characteristics as introduced in the theoretical framework. The IASB argues that the degree of usefulness depends on four enhancing qualitative characteristics. The degree of usefulness of financial reports contributes to relevant information and a faithful representation of the information. The enhancing qualitative characteristics are able to improve decision usefulness for users of financial reporting. However, these characteristics cannot determine the quality of financial reporting on their own (IASB, 2008). For this reason, the dimensions of reporting quality as introduced in the previous chapter are reviewed in this chapter as well. Firstly, the four characteristics are examined after which the two remaining dimensions of reporting quality, earnings management and value relevance, are discussed.

4.1. Comparability

The first enhancing qualitative characteristic discussed is the concept of comparability. Comparability relates to the quality of information that enables “users to identify similarities in and differences

between two sets of economic phenomena”. (IASB, 2008, p. 39). This means that similar situations

should be treated and presented the same and different situations should be presented differently. The strongest effects of implementing IFRS appeared in the countries with the largest difference between the national GAAP and IFRS (Aharony et al., 2010; Barth et al., 2010; Daske et al., 2008). It is reasonable to assume that the harmonisation of accounting standards would lead to better comparability, both cross-country as cross-firm. However, research showed that the

implementation of IFRS does not necessarily guarantee a convergence of accounting standards and does not guarantee an increase in comparability (Ball, 2006; Daske et al., 2013; Nelson, 2003). Brochet et al. (2013) did a study on the effects of a transition from national GAAP to IFRS in the UK and they concluded that the adoption of IFRS was less likely to change the quality in financial

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transitioning to IFRS, allowing the UK to be used as a benchmark to evaluate the financial reporting quality of other countries. Nonetheless, they stated that comparability was enhanced due to the mandatory implementation of IFRS.

Van Beest et al. (2009) argued that within comparability, consistency is included.

“Consistency refers to the use of the same accounting policies and procedures, either from period to

period within an entity or in a single period across entities” (IASB, 2008, p. 39). Guggiola (2010)

discovered, in a study on the effects of IFRS on accounting harmonization and market efficiency, that the adoption of IFRS as a unique and internationally recognized accounting standard increased the comparability of financial statements. Not only did IFRS increase the comparability among companies, it affected companies from different countries as well. She stated that the higher comparability enabled analysts to lower learning costs they face when dealing with financial statements drawn under different accounting standards. Barth et al. (2006; 2007) add on to this by declaring that an improvement in comparability leads to a decrease in earnings management, as this makes it more complicated for managers to manipulate accounting numbers. Additionally, by

standardising financial statements and eliminating differences in accounting standards, IFRS adoption could reduce the adjustments analysts have to make to make financial statements more comparable, thus reducing the costs of processing financial information to investors (Ball, 2006).

Overall, it can be concluded that the comparability both between companies as between companies from different countries has increased due to the mandatory implementation of IFRS. Hence, financial reporting quality improved.

4.2. Verifiability

The second enhancing qualitative characteristic is verifiability. Verifiability helps assure users of financial reporting that the information in financial statements faithfully represents economic phenomena that it should represent. It implies that different users of financial information reach a general consensus, if not complete agreement (IASB, 2008, p. 39). Research has shown that the merging of accounting standards by implementing IFRS has strengthened verifiability (Byard et al., 2010; Preiato et al., 2009). They both found that the implementation of IFRS led to a decrease in forecast error and forecast dispersion, meaning that a larger group of users comes to the same

conclusion based upon the information presented in financial reports. On the other hand, the standards do not guarantee an absolute compliance in practice, especially if the standards were already

principles-based (Ball, 2006; Daske et al., 2013). Argued is that the degree of professional judgement permitted in a principles-based standard impedes the verifiability (Nobes, 2006). However, in my

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opinion it is not likely that firms will deviate too much from the giving principles in an accounting standard, as the interpretation of an accounting standard are well thought out and discussed within the accounting provision.

Overall, it is clear that the verifiability of financial information improved after the mandatory IFRS adoption. An increase in verifiability means an improvement in reporting quality.

4.3. Timeliness

As the third enhancing qualitative characteristic, timeliness is introduced. Timeliness is mostly measured as asymmetric timeliness, the recognition of large losses opposed to deferring large losses (Ball, 2006; Barth et al., 2008; Chen et al., 2010). Research by Barth et al. (2008) on country-specific effects discovered a decrease in timeliness. A decrease in timeliness could also indicate an increase in earnings management, as earnings management enables managers to withhold from the reporting of large losses.

Additionally, Bushman et al. (2006) found evidence that supports the concept of timely loss recognition. They report that firms that recognise losses on a timelier basis are less likely to engage in negative-NPV investments. An increase in transparency and timely loss recognition caused by IFRS implementation can therefore improve the efficiency of contracting between managers and companies; it could reduce agency costs between managers and stakeholders and thus improve corporate

governance. More specifically, a more timely recognition of losses in financial reporting increases the incentives for managers to be knowledgeable of existing loss-making strategies and investments. In turn, fewer new investments with negative NPV’s will be likely to be made (Ball, 2006; Ball & Shivakumar, 2005). Moreover, increased transparency of financial statements induces managers to act more in the interest of stakeholders (Ball, 2006).

Dimitropoulos et al. (2013) performed a study on the mandatory adoption of IFRS in Greece, which enabled them to do a study including only mandatory adopters. This way, the study was not exposed to a possible self-selection bias from voluntary adopters. Found was that after the

implementation of IFRS, the probability of large losses being disclosed in a timely manner instead of being deferred is higher than in the period prior to the IFRS implementation in Greece. In other words, an increase in timeliness is found.

Contrarily, Lin et al (2012) concluded that companies showed a lower degree of conservatism after the transition to IFRS. They performed their study on the impact of IFRS implementation on the reporting quality of German firms. Germany prepared their financial statements under US GAAP prior to switching to IFRS, meaning a switch from a rules-based accounting standard to a more

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principles-based accounting standard. Their overall conclusion regarding timely loss recognition was that reporting quality had decreased after the implementation of IFRS. Research done by Paglietti (2009) can add to this, stating that the reporting quality of Italian companies deteriorated after the

implementation of IFRS. The firms were less likely to recognise larger losses in a timely manner when they switched to preparing under IFRS than before, which implies a decrease in reporting quality. However, it is stated that the Italian firms display higher timeliness in recognising losses in comparison to recognising gains. Nonetheless, it is apparent that the absence of a conservative attitude towards loss recognition leads to a lower quality of financial reporting.

According to three of the four research studies described above, the degree of timely loss recognition decreased after the mandatory switch to IFRS. Only one study found an increase in timeliness. Hence, it can be concluded that a decrease in reporting quality after IFRS implementation was observable.

4.4. Understandability

The last enhancing qualitative characteristic defined in the Conceptual Framework is

understandability. This characteristic will increase when information is accurately classified, characterised and presented clearly and briefly (van Beest et al., 2009). IASB (2008) defines this concept as “the quality of information that enables users to envision the meaning of financial

statements”. Arguably is that when the information in the financial reports is well organised, the

information can be classified and characterised as understandable. When the financial report is well organised, it is easier to understand where to look for specific aspects of information (Jones &

Blanchet, 2000). Moreover, the disclosure of additional information, like the notes to the balance sheet and income statement, can be valuable in the explanation and provision of more insight into the

numbers and figures (Beretta & Bozzolan, 2004).

Relating to this characteristic, it primarily depends on the difference between IFRS and the previously used national GAAP. It is reasonable to state that the understandability of IFRS is higher when the differences between the previously used standard and IFRS are small. However, Chen et al. (2010) argued that IFRS are generally easier to interpret and implement than previously used national GAAP, thus improving accounting quality. Nevertheless, Schipper (2003) stated that the widespread implementation of IFRS caused significant confusion about how to implement IFRS, resulting in users demanding a detailed guidance.

The process of understanding and implementing a new accounting standard takes time. For that reason, Cuijpers & Buijink (2005) found that early adopters that adopted IFRS voluntarily, prior to the mandatory implementation, gained more benefits than the firms and countries that implemented

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IFRS later. Sunder (2009) stated that through pressure exerted by firms and politics, the standards would become more detailed resulting in more rules-based over time. According to van Hulle (1993) this is in line with the objective of the IASB, namely to eliminate the range of different options and to develop a uniform standard. A uniform standard would increase the overall understandability of financial information, because the need to understand the underlying domestic accounting standard is eliminated (Jeanjean & Stolowy, 2008). Ewert and Wagenhofer (2005) added that the elimination of the range of options restricts discretion and therefore improves reporting quality by reducing earnings management. Barth et al. (2009), however, argued differently. They stated that uniformity could create an increase in the noise in accounting numbers, since the uniformity of accounting standards does not particularly mean uniformity of underlying national economic backgrounds.

Overall, it can be concluded that reporting quality improved after the IFRS implementation, based on the characteristic of understandability. However, this is not a clear cut conclusion. The studies mentioned above have made serious doubts about this characteristic.

4.5. Earnings management

Concerning the first dimension to measure reporting quality, a lot of research has been done (Schipper, 2003; Healy & Wahlen, 1999, Van Beest, 2011). Earnings management is a purposeful intervention by managers in the financial reporting either to mislead stakeholders or to influence contractual outcomes (Schipper, 2003; Healy & Wahlen, 1999). As the users of financial statements are dependent on the numbers and figures represented in the statements, it is important that these are truthful and of high quality. Hence, the likelihood of earnings management to occur should be as small as possible. Dimitropoulos et al. (2013) reported, in their study on mandatory implementation in Greece, that reporting quality through earnings management improved after the country switched to IFRS. They reported less earnings management, because the firms in the sample appeared to engage in less earnings smoothing practices. Lin et al. (2012) based their study on German firms that reported under US GAAP prior to the mandatory switch to IFRS. They found a higher degree of earnings management in the period after implementation of IFRS than in the period before implementation under US GAAP. As US GAAP are considered rules-based standards and IFRS as principles-based standards, the findings from Lin et al. provide evidence of possible implications of switching from a rules-based standard to a more principles-based standard. Van Beest (2011) stated that reporting quality could decrease due to more opportunity for professional judgement under IFRS. Contrarily, at the same time he argued that reporting quality could improve due to a more faithful representation of the underlying economic situation of the firm under IFRS. Additionally, Paglietti (2009) found that the opportunity for earnings smoothing among Italian firms increased after the implementation, which

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results in a decrease in reporting quality. The diminishing in quality can be attributed by the flexibility that is characterising for principles-based standards, as previously stated by Barth et al. (2008).

Again, the literature is inconclusive about the degree of earnings management after the switch to IFRS. The studies described above do not fully resolve all doubts or questions concerning earnings management. Three of the four studies reported a possible or certain increase in earnings management, where one study reported a decrease in earnings management. Overall, the findings presented above imply an increase in earnings management after the IFRS implementation, thus a decrease in reporting quality.

4.6. Value relevance

The second dimension to measure reporting quality is value relevance. Value relevance is explained as how well accounting amounts display information used by investors. The higher the association

between share price and returns, the higher reporting quality is considered to be (Barth et al., 2008). In other words, this way the accounting date better explains the price of the stock. Dimitropoulos et al. (2013) concluded that value relevance improved after the mandatory implementation of IFRS for Greek firms, therefore improving the reporting quality of financial statements. This implies that a transition from principles-based accounting standards to principles-based accounting standards, like the switch in Greece, is accompanied with an improvement in reporting quality. Opposed to this, Lin et al. (2012) argued that reporting quality deteriorated after the adoption of IFRS in Germany, through a decrease of value relevance. Accounting information appeared to be more useful for investors in the period prior to IFRS adoption than in the period after adoption. Paglietti (2009) however, found that accounting numbers are more informative for users after IFRS implementation. The process of providing useful information to investors for their decision-making process improved, thus this implies that reporting quality improved after the switch to using IFRS.

Despite the fact that the study from Lin et al. (2012) reported a decrease in value relevance, it can be concluded that value relevance improved after switching to IFRS. An increase in value

relevance leads to an improvement in reporting quality.

4.7. Other relevant factors

Generally, the findings as presented above do not display consistent results in terms of the impact of the mandatory implementation of IFRS. As mentioned by Cuijpers & Buijink (2005), the adoption and implementation of a new accounting standard takes time and is costly, which might be a reason for the inconsistency in the results. Moreover, Ball (2006) declared that the use of a single set of accounting

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standard might not improve quality of financial reporting because of additional legal and political factors for each firm and country. Guggiola (2010) stated that the quality of financial information provided in financial statements is not only influenced by accounting standards, it is also influenced by other factors. Other factors such as the capital structure of the firm, the legal system of the country where the firm is located or the level of investors’ protection in certain countries. Figure 4 represents the various determinants of accounting quality. It is visible that besides accounting standards, the legal and political system and incentives of financial reporting all have its direct effects accounting quality. Besides this, the legal and political system of a country also has an indirect effect on accounting quality.

Figure 4: Determinants of Accounting Quality

Reprinted from “IFRS Adoption and Accounting Quality: A Review” Soderstrom & Sun, 2007, p. 45 Although it is likely that the mandatory IFRS implementation affected reporting quality, it is only one of the determinants of accounting quality (Soderstrom & Sun, 2007). Therefore, it is likely to assume that reporting quality will differ across countries, as the determinants differ across countries.

4.8. Overall conclusion

Based on what is discussed above I tend to argue that reporting quality of firms in Europe has

improved after the mandatory implementation of IFRS. Appendix 1 provides a complete overview of the used studies and its findings.

Concerning the first characteristic comparability the literature is consistent. All three studies mentioned in this section reported an increase in comparability after the mandatory implementation of

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IFRS. Therefore, it can be concluded that the financial reporting quality improved. Likewise, the findings on verifiability are consistent. Studies by Byard et al. (2010) and Preiato et al. (2009) both declared an improvement in verifiability after the mandatory switch to IFRS. Thus, the increased degree of verifiability of financial information ensures high quality of financial reporting.

The findings on timeliness, however, did not report of improvements of reporting quality. Three of four studies analysed reported a decrease in timely loss recognition after the implementation of IFRS. Firms showed a lower degree of conservatism, meaning the deferral of losses was more likely to appear than the recognition of losses in a timely manner. Hence, reporting quality regarding timeliness decreased after the mandatory implementation of IFRS. The last enhancing qualitative characteristic understandability improved after the implementation of IFRS. The findings are not completely clear-cut, as several studies made doubts about the implementation of this characteristic.

Concerning earnings management, the literature is inconclusive. Three of the four studies reported an increase in earnings management, meaning the firms that were studied appeared to engage in more earnings smoothing practices. However, a study done by Dimitropoulos et al. (2013) reported that reporting quality improved through less earnings management. Nonetheless, the findings imply an increase in earnings management, thus a decrease in reporting quality after the mandatory

implementation of IFRS. The findings on value relevance indicate that this dimension improved after the implementation, thus leading to an improvement in reporting quality. Overall, it can be concluded that reporting quality of firms in Europe reporting under IFRS has improved after the mandatory implementation.

However, this conclusion is weakened by the fact that other factors relating to reporting quality are of substantial importance. Reporting quality is not only affected by the choice of

accounting standard, it is also dependent on the quality of the standards, the legal and political system of a country and financial reporting incentives like the country’s tax system. To optimally improve reporting quality, it would be beneficial to consider all these different factors.

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Chapter 5: Conclusion

From January 1 2005, every listed firm in the European Union is obliged to prepare its financial statements under IFRS. The aim of this thesis was to examine the relation between the mandatory IFRS implementation and the quality of financial reporting for the countries in Europe that

implemented IFRS. More clearly, to contribute to the ongoing discussion whether the IASB succeeded in their objective of issuing high quality, globally accepted financial reporting standards through both the implementation of IFRS and the convergence of US GAAP and IFRS. It was expected that IFRS would improve the quality of financial reporting and thus improve the financial information for

stakeholders. By means of a literature review, the impact of the mandatory implementation of IFRS on reporting quality was measured. The research question of this thesis was: How did the mandatory implementation of IFRS affect financial reporting quality in Europe? This final chapter draws a conclusion based on the findings discussed in the previous chapter and in turn, an answer is given to the research question. Finally, the limitations to this research are discussed and suggestions for further research are done.

In the theoretical framework, the theory necessary to understand the research question was discussed. The second chapter included the history behind IFRS and the Conceptual Framework, including the concepts for preparation and presentation of financial reporting. The third chapter explained the concept of reporting quality and its dimensions.

I have followed the following steps concerning the analysis of the research regarding the impact of the mandatory IFRS implementation.Firstly, I examined whether the implementation of IFRS improved the four enhancing qualitative characteristics comparability, verifiability, timeliness and understandability. Prior research was reviewed in order to compare between the findings. I found that comparability, verifiability and understandability improved after the transition to IFRS. These findings indicate an improvement in reporting quality. Regarding the characteristic of timeliness however, prior research reported a decrease in timely loss recognition. Hence, this implies a deterioration of reporting quality.

Next, I examined whether the two remaining dimensions of reporting quality, earnings

management and value relevance, showed an improvement due to the IFRS implementation. Research showed that firms engaged in earnings management more in the period after the IFRS implementation, implying a decrease in quality of financial reporting. Research on value relevance on the other hand, showed an increase. Therefore, an increase in reporting quality can be concluded regarding value relevance.

The change in quality of financial reporting after the mandatory implementation of IFRS in Europe : a literature review