Lobbying on IFRS 9: Has Earnings
Management Influence on this?
Student: Emmanuel Boekholt Student number: 5732115
Date: 23-6-2014
First reader: Sanjay Bissessur, Dr Second reader:
Course: Master Thesis Accountancy Georgios Georgakopoulos, Dr
Inhoudsopgave
1. Introduction 2
2. Standard setting, IFRS 9 and Earnings management 4
2.1. Earnings management 4
2.2. Standard setting 7
2.3. IAS 39 vs IFRS 9 12
2.4. Hypothesis 17
3. Methodology and Data 18
3.1. Methodology 18
3.2. Data 20
4. Results 23
4.1. Interaction ALLP and LETTER 23
4.2. Additional analysis 24
5. Conclusion 26
A. References 28
1.
Introduction
Now that the financial banking crisis of the late 2000s is smoothing out, the International Accounting Standard Board (IASB) is returning to work on their update for the widely discussed regulations on the credit-loss recognition of financial instruments. During the financial banking crisis, one of the larger issues described was the delayed recognition of credit losses. This delay lead to the problem that financial institutions could be falling behind on what was going to happen (O’Hanlon, 2013). They could already see problems arise but could not do anything because of regulations in IAS 39. Within IAS 39 is stated that:
“A financial asset or group of assets is impaired, and impairment losses are recognised, only if there is objective evidence as a result of one or more events that occurred after the initial recognition of the asset” (IASplus, 39.65).
The gathering of this evidence is part of the incurred-loss method. This method
received a lot of attention during the financial crisis in 2008 (O’Hanlon, 2013). To make sure this will not happen again in the future the IASB, in combination with the Financial
Accounting Standard Board (FASB), is working on new regulations, International Financial Reporting Standards (IFRS) 9. (IASB, 2013). With this new regulation they try with a more future looking model, to recognize the credit losses. At the start this model was meant to be a joint project between the FASB and IASB to create a universal model. However the FASB revisited the model in 2012 and developed a different expected credit loss model (Current Expected Credit Loss, CECL). The IASB kept the original model, the Expected Credit Loss-model (ECL). This research is focused on the Loss-model developed by the IASB.
The change from the incurred loss model to the new expected credit loss model is presented to the community using an exposure draft (ED) issued by the IASB. Most of the responding parties, which represent preparers, regulators, auditors and user, support the proposal from the ED (IFRS 5c, 2013). Even though most respondents support the ED there were still some issues mentioned in the comment letters. One of these issues presented by the regulators and standard-setters is that the ECL model will increase the subjectivity of the deterioration assessment. Which will increase the possibility of manipulation (IASB 5c, 2013, p.14).
Kosi and Reither (2014) show in their research that entities that have financial
constraints are more likely to lobby. But a change in accounting regulations can influence the lobbying behavior for financial firms. This is according to Kosi and Reither (2014) in line
with the non-financial firm. The authors find that the financial firms use lobbying for self-interest. To see the influence of this self-interest, this has paper will research if preparers that lobby on the IFRS 9 ED for the expected credit loss model, use more earnings management. The firms that participate in this lobby activity are firms that made the decision to submit a responds to the ED. They can do this individually or through the participation of a
representative group. Even though earnings management can be used in multiple methods, within this research the focus will be on the loan loss provision.
The results of this paper show that there is a significant interaction between
participation in lobbying and the use of earnings management through loan loss provision. Thereby with the use of an additional analysis there is looked if the issues presented by the prepares have any influence on the valuation of the loan loss provision. But the issues they present do not strongly indicate that the prepares are looking for ways to have more possibilities to influence the calculation of the loan loss provision.
The rest of this paper is organized into 5 sections. Section 2 presents a summary of the literature on lobbying through the use of comment letters, a summary on the new IFRS 9 regulation for banks and earnings management through the loan loss provision. The
methodology and data will be presented in section 3. Section 4 presents the results. Section 5 concludes.
2.
Standard setting, IFRS 9 and Earnings management
In the following paragraphs I will elaborate the three subjects that are important for this research. Even though that the subjects does not related to different parts in the economic process, they are still connected to each other because they influence each other. At first a more on Earnings management, secondly a detailed view on how standard setting is done and finally I will present a summary of IFRS 9 and a comparison with the old standard IAS 39.
2.1.
Earnings management
In the ongoing globalization of the accounting standards the standards-setters and regulators will always have to think about the how much judgement is allowed for management in preparing of the financial reports (Healy and Wahlen, 1999). The judgement for managers is the experience a manager has to estimate the value for future events or for valuating
precautionary measures. With the use of their judgement managers can influence the earnings they are reporting to the stakeholders, also known as earnings management. Healy and
Wahlen (1999) gives a definition for the term earnings management:
‘Earnings management occurs when managers use judgment in
financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to infiuence contractual outcomes that depend on reported accounting numbers’ (p.368).
According to the authors this definition does not cover the complete explanation of earnings management (Healy and Wahlen, 1999). To amplify the definition Nelson et al (2002) quote Schipper (1989), which say that:
‘Earnings management can be defined as non-neutral financial
reporting in which managers intervene intentionally in the financial reporting process to produce some private gain (Schipper, 1989).’ (p.176)
When combining both definitions it shows that managers can influence the financial reporting and engage or participate in earnings management by using their judgement. When managers
use their judgement to influence or intervene in the financial reporting process, they are intentionally influencing the information and financial numbers. Besides their judgement, managers also have another way to influence financial reporting. This can be done by the interpretation of accounting standards and the application of these accounting standards on events that already have occurred. By using their own interpretation of the standard, a manager can shift accounting earnings between periods (Healy and Wahlen, 1999; Nelson et al, 2002; Ewert and Wagenhofer, 2005). Within the banking industry there is less possibility for managers to time or structure transactions. But because of the large amount of regulations and accounting standards managers in the banking industry have more opportunities to use accounting earnings management (Cheng et al., 2011).
The reason for managers in general to use earnings management can have different reasons. They can do it for their own benefit, to achieve certain targets or expectations and they can use it to measure up to contractual outcomes. Chang et al. (2008) give a more global view. They state that managers engage in earnings management because of capital market incentives, which include management buyout plans, an initial public offerings, merger plans, smoothing earnings and meeting benchmark or earnings forecast. Secondly managers can have contract motivations to manage earnings, for example debt covenants or debt agreement, management compensation plans or job preservation (also known or described as job
security). There is evidence found that there is more earnings management when management compensation is closer tied to the value of the stocks (Cohen et al., 2014). The last general reason for earnings management are the regulation motivation, such as antitrust regulation, industry-specific regulation and import regulation (Chang et al., 2008; Nelson et al., 2002; Healy and Wahlen, 1999)a. Within the banking sector managers have also incentives to participate in earnings management to maximize their own or the banks wealth. They also have the same incentives described as above for non-financial companies. When looking at studies from the pas the researches have a larger focus on the capital market incentives, specific the smoothing of earnings and the reduction of earnings volatility (e.g. Ahmed et al.,1999; Cheng et al., 2011). These incentives are more based on maximizing the wealth of the whole bank. When looking at other studies which focus more on the managers perspective (e.g. Chang et al., 2011, there is more focus on the contract motivations. In practice this lead to earnings management to preservation of the job and/or to maximize the compensation plan.
a
There is only looked at incentives that are relevant for this research. For example, there will not looked at studies which discuss the use of signaling as incentive for earnings management.
When looking at the possibilities that managers have to perform earnings
management, there are two possibilities. First there is use of real earnings management, and second there is accrual based or accounting earnings management. Real earnings management is done by planning operational decisions to ‘adjust’ the reported earnings (Healy and
Wahlen, 1999; Roychowdhury, 2006). As mentioned by Roychowdhury (2006) managers can use for example the acceleration of sales, the delaying of research and development (R&D) and maintenance expenditures as earnings management methods. Al the latter examples have a direct impact on the cash flow of the company and can even lead to a decrease in firm value. For instance by accelerating the sales in one period this could create a lower sale in the future and there for lower the firm value (Roychowdhury, 2006). The financial industry is an
industry which provides services to customers. These services are without an tangible product. This absence of a tangible products reduces the possibilities for managers from financial companies to use real earnings management. In prior literature there is looked at the short-term gains and losses from securities, which can be used for real earnings management (Chang et. al., 2011). But with the use of fair value accounting the gains and losses on securities can also be influenced by discretion of the managers (Cohen et al., 2014).
When we look at the accrual based earnings management, a manager has to possible ways for earnings management. As mentioned before, managers can use their own judgement or discretion to influence the financial reporting. Besides the discretion that a manger can use to influence financial reporting they also can choose to use different accounting methods for the same transaction (Healy and Wahlen, 1999). As an example for the change in accounting methods, the valuation of inventory. This can be done through Last-In, Out(LIFO), First-In, First-Out (FIFO) or historical cost price. So when looking at the accrual based earnings management most entities can use multiple accounting area’s on how to perform earnings management. Some of the possibilities are intangibles, revenue recognition, investments and leases, but the most used by managers is the use of reserves (Nelson et al., 2002) and
mentioned above the gains and losses on securities (Cohen et al., 2014). There are multiple reserves which can be used for the accounting earnings management, this is dependent on the industry an entity operates in. In the banking industry entities can use multiple accruals to manage their earnings. But the most used accrual in this industry is the loan loss provision (LLP).
The LLP is an expense which is reflecting the judgement of a manager to about the likelihood of future losses from defaults on outstanding loans. When a manager chooses to increase the LLP this will reduce the profit of the company and vice versa, when the LLP is
reduced than the profit for a company will increase. The accumulated LLP is presented on the balance sheet as loan loss allowance. Financial regulators see the loan loss allowance as a form of capital which can be used to absorb unexpected losses (Cohen et al., 2014) The choose of the manager to increase or decrease is depending on the estimation of the losses they expect due to defaults on the outstanding loans. The moment for valuation of the expected loan losses will be done at each balance sheet date (Gebhardt and Novotny-Farkas, 2011) or as it is stated by the standard setters, the valuation will be done at reporting date (IASB, 39.58; ED 2013/3). The objective evidence (current standard) or the expectation (proposed standard) influence the valuation of the defaults. Which lead to that the LLP can have a significantly influence on the reported earnings of banks (Gebhardt and Novotny-Farkas, 2011).
The underlying aspect for the estimation is the credit risk banks have on the
outstanding loans. This credit risk is one of the most important risk factor. Banks are trying to reduce the credit risk with the creation of LLP (Pérez et al., 2008).
As mentioned before it is important for standard-setters to balance the amount of judgement a manager have. For this the standard-setters need information on the following four points; (1) the magnitude and frequency of any earnings management, (2) specific accruals and accounting methods used to manage earnings, (3) motives for earnings management, and (4) any recourse allocation effects in the economy (Healy and Wahlen, 1999, p.367). Ewert and Wagenhofer (2005) has a more general perception on this. The say that the standard setters are interested in the average effect of the change in the policy. No the less, the information about magnitude and frequency of earnings management can help the standard setter to find out if and to what extend managers use earnings management and if the deceive the investors with it. The other three questions give more insight in the new standard that can be up for review or intensification (Healy and Wahlen, 1999). When the standards are more review or amended to tightening the standard. This reduced the effectiveness of
accounting earnings management according to Ewert and Wagenhofer (2005). For example With the implementation of IAS 39, the leeway for managers to use discretion is reduced by the incurred loss model (Gebhardt and Novotny-Farkas, 2011).
2.2.
Standard setting
By making the accounting profession inextricably connected to the business community. The business community, investors, creditors and other financial interested cannot function without depending on auditors (Gerboth, 1973). This dependency from the auditors created
the need to come up with regulations and standards which have to be followed by everyone. Sutton (1984) already show that the setting of financial standard has become an political activity. This is now even more genuine because the standard regulations are implemented by European government, which has also the responsibility to control the implemented standards. To create and due process to establish the standards. The standards are prepared by an
independent and private-sector organisation with no elected or governmental authority (Jorissen et al., 2012). This organisation is the International Accounting Standard Board (IASB) which found his legitimacy in the transparent standard setting process with participation possibilities for every interested party (Jorrisen et al., 2012). The IASB is working on the International Financial Reporting Standards (IFRS) to create and improve standards and bring it to a global audience (Georgiou, 2010).
The increasing adoption of countries using IFRS, in 130 countries so far (IFRS.org), leads to an increased interest from the academic world to do more research on the economic consequences of IFRS adoption (Ahmed et al., 2013). The basis for the global acceptation of IFRS lies in the legitimacy that the IASB has for standard setting (Jorissen et al., 2013) and the increasing of value relevance and reliability of accounting amounts and information (Barth et al., 2001; Ahmed et al., 2013). When the value relevance and reliability of accounting information are increased then the idea behind the regulation is achieved by lowering the information asymmetry between agents and principles. Brown (2011) also gives the elimination of cross-border trading, increase in comparability, increase in market
efficiency and the reduction of cost of raising capital as potential benefits of adopting IFRS (p.271).
The information asymmetry or information gap which exist between principles (the stakeholders of a company) and the agents (the managers within the company) arises from the agency theory. The agency theory is described by Jensen and Meckling (1976) “ as a contract under which one or more persons (the principal(s)) engage another person (the agent) to perform service on their behalf which involves delegating some decision making authority to the agent” (p.308). If both parties want to maximize their own benefit this could lead to the problem that the agent will not necessarily act in the best interest of the principle (Jensen and Meckling, 1976). The service performed by the agent are reported back to the principals can be biased, the managers can withhold specific information or alter the presented information to maximize his own benefits, leading to an information asymmetry. Because of the
arguments just mentioned before, there are standards and regulation constructed to reduce the information asymmetry.
The legitimacy used by Jorissen et al. (2013) is defined as follows: ‘Legitimacy is a generalized perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and
definitions’ (Suchman, 1995, p. 574).To create this legitimacy for the standard-setter and the standards, the standard-setter has to give or create the possibility for stakeholders to give their input on the new standards (Larson and Herz, 2013; Orens et al., 2011). According to Barth et al. (2001) an accounting amount is relevant if it influence the decision made by a financial statement user. The accounting amount is reliable if it represents what it needs to represent (p.80). With the acceptation of IFRS by (European) politics there is an increase in the necessity of value relevance research (Ahmed et al., 2013) and an understatement for an increase in legitimacy of the standards within IFRS.
The process used by the IASB to retain the legitimacy on IFRS is done by using a due process where every constituent (e.g. managers, shareholders, government or regulators) can participate in. This participation ability, is mostly used in the process of creating new
standards. This is an international consultation process or due process. With this due process the IASB want to get interested individuals and organisations to respond throughout the different steps in the process. The due process the IASB use exist of six stages. The stages that the IASB use to develop a new standard are: first there is stage I, which involve the setting of the agenda for a new standard. To accept an item on the agenda, the IASB look for issues that have to be solved to create better-quality information, valued by all users of the financial statement. The final decision to adopt a new project is done in a public IASB meeting where constituents can present subjects that are provided in advanced (public
hearings) or when interested parties are invited to discuss on previously circulating questions (public round-tables). Then Stage II follows, this is the planning of the project. For the planning the IASB look if the new standard will developed alone or that it will be a joint project with another standard-setter. The next stage is stage III, this is about developing and publishing the discussion paper (DP). The DP is a paper which is used to give a
comprehensive overview of the issue as presented in stage I. Also incorporated in the DP are possible approaches on the subject, a preliminary view of the author (if it is from a different standard-setter) or IASB and constituents are invited to share their ideas on the new project. This step does not necessarily to be performed for every new project, because it is not a mandatory step to perform by the IASB. In stage IV, Developing and publishing the exposure draft (ED). Unlike the DP the ED is mandatory to publish, because it is the main way to consulting the constituents. The proposal in the ED is different than that from the DP, because
in the ED there is an proposed standard published, which is constructed based on the issues found by staff research, recommendations or comments received on the DP and suggestions presented by the IFRS advisory council working group. The constituents are again invited to comment on this ED. Then in stage V, the IASB will be developing and publishing the standard. The publication or pre-voting draft is only done when the IASB decides that after resolving the issues that are presented in the comments on the ED do not need to be exposed any more. This process of resolving the issues and decision if the revised proposal should be exposed again is made in IASB meetings. A pre-ballot draft is usually presented to external review just before the IASB votes on the standard. And finally stage VI, where the IASB follows the implementation of the new standard by holding regular meetings with interested parties. This is done to understand unexpected issues and the effect this can have on the proposal (IFRS, 2014; Jorissen et al., 2013; Orens et al. 2011))
In the due process presented above the constituents get opportunities to respond and try to influence the standard-setter by participating or lobbying in the due process (Giner and Arce, 2012) . The decision to participate in lobbying by the preparers is according to
Georgiou (2004) made by a couple of interrelated issues. The first is whether to lobby or not. To make this decision the constituent looks if the benefits from successful lobbying exceed the cost. Secondly when the constituent do want to lobby, it needs to know which method to use, this could be the direct or indirect method. As third, the constituent needs to make a decision when to lobby, this can be done at an early stage in the standard setting process or later on in the process. Finally the constituent has to decide what for arguments to use, theoretical or economic arguments. The previous given issues will be further elaborated and explained in the next part. The idea of lobbying and addressing issues in the new standard to the standard setting party arises from the interest group theory.
The interest group theory, is a theory which state that groups with the same interest will try to achieve the same purpose. They do this by participating as a group in politics that can influence their proceedings. This is similar to the self-interest theory, which sees the accounting standard setting as a political process where self-interest parties want to influence the standard setting body (Klein and Fulbier, 2014).
According to Orens et al. (2011) the benefits of lobbying are the depending on the potential impact of the expected future cash flows of the preparer, adjusted with the probability that lobbying will have influence on the outcome of the standard. The cost-effectiveness which determine if the stakeholder should participate in lobbying, is according to Sutton (1984) not possible to rank. But he shows that, as conclusions from observing of
lobbyist behaviour, direct measures are more effective then indirect methods. The cost-effectiveness is also depended on the size of the company, if looking at prepares of financial reports. Larger company are more likely to lobby (Sutton, 1984;)
There are multiple ways how companies can lobby for their own interest. They can do this by using direct or indirect methods. A direct method can be directly send the comment letter to standard setter (Georgiou, 2004; Orens et al., 201; Larson and Herz, 2013). With the indirect method firms are e.g. communicating their opinion to their auditor or to local
standard-setters.
With the publication of the exposure draft and the discussion paper the IASB is using a formal method to incorporate public consultation. With this method the IASB gives
constituents the possibility to respond on the new standard and give their opinion on it. To give a more direct opinion, stakeholders can also do this in an informal way, e.g. meeting with board members (Orens et al., 2011). To see how the formal and informal methods of the IASB and the direct or indirect methods of the prepares Orens et al. (2011) combine the possibilities in a matrix (Table 1).
Table 1 Participation methods to influence the IASB
Formal lobbying method Informal lobbying method Direct
lobbying methods
Submitting a comment letter to the standard setter in response to a public request.
Paticipating in private meetings or telephone conversations with members of the standard setter.
Participating as a consultant in project groups.
Participating in public roundtable discussions.
Indirect lobbying methods
Submitting comments to members of the Standard Accounting Council (SAC).
Submitting comments to external auditor Submitting comments to the European
Financial Reporting Advisory Group (EFRAG).
Submitting comments to the industry organization.
This table reports participation methods available to exert influence on the IASB (table designed by Orens et al., 2011, p. 215)
As already stated by Sutton (1984), the cost-effectiveness of the method used to lobby is not possible to place in an ranking, but from the observation the best way is to have private meetings with the standard-setters. Georgiou (2010) findings don’t agree with this, he find that the most popular is to appeal to a trade organisations. The second best method presented by Georgiou (2010) is the submission of comment letters. The use of comment letters is also a method which is frequently used by researchers to measure lobbying (e.g. Larson and Herz,
2013; Giner and Arce, 2012). When looking at the research for comment letters Durocher et al. (2007) is used by multiple studies to create a theoretical framework on who an why constituents participate in the lobbying through comment letters (Jorissen et al, 2012; Mora and Molina, 2014). The theoretical framework describes three different theory groups: the Economic Theory of Democracy Group (ETD), the Positive Accounting Theory Group (PAT) and the Coalition and Influencing Group (CI). Within the ETD the tendency to lobby is based on two assumptions, the expected wealth effect and the possibility of influencing the final decision. The ETD focus on all constituents within the due process. While the PAT focus mostly on the prepares of financial reporting, because this theory stated that there is a relation between the economic consequences, which impact accounting figures used for contract, of the proposal and the willingness to participate. The CI analysis the of individuals and groups of constituents in trying to influence the standard setter in its final decision through lobbying (Jorissen et al, 2012; Mora and Molina, 2014).
To see if lobbying pays off or what the reaction of the standard setter is on the comment letters we are still partly in the dark. As mentioned by Klein and Fulbier (2014) there is no in depth research on the board-internal process of standard setting. The authors do mention that the when constituents participate this can affect the group decisions.
2.3.
IAS 39 vs IFRS 9
To get a good understanding on what the influence is of the new standard. I will give a summary of IAS 39 shown as the basic rules for recognising, measuring and impairing financial assets and financial liabilities. This will be followed by a summary of IFRS 9 and in the end they will be compared.
IAS 39
With the standard of IAS 39 the IASC and later the IASB has as intention to establish principles for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items (IASB, 2013, 39.1). To breakdown the financial assets, financial liabilities and contracts to buy or sell non-financial items IAS 39 gives four categories to present the financial instruments: (1) financial asset or financial liability at fair value through profit or loss, in which the assets or liability is classified as held for trading or when it is designated by the entity. (2) Held-to-maturity investments, are financial assets that are non-derivative and have a fixed determinable payment and fixed maturity for which the entity has positive intention to keep the asset till maturity. (3) Loans and receivables are
non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. (4) Available-for-sale financial asset, this category is used if the criteria for the previous three categories are not applicable (IASB, 2013, 39.9).
The measuring of financial assets and liabilities will be done upon initial recognition based on the fair value, except in the case of financial assets and financial liabilities not at fair value through profit or loss there will be the transaction cost that are directly imputable to the acquiring of the asset or liability (IASB,2013, 39.43). The subsequent measuring of financial assets can be done in three way’s. At base it is done at fair value except for loans and
receivables, held-to-maturity investments and investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be measure reliably. Held-to-maturity investments and loans and receivables will be measured at amortised cost using the effective interest method. The investments in equity instruments without a quoted market price are measured at cost (IASB, 2013, 39.46). Subsequent
measuring of financial liabilities is done at amortised cost using the effective interest method, except for; financial liabilities at fair value through profit and loss (at fair value), financial liabilities that are the result from a transfer of a financial asset that does nog qualify for derecognition (measured at the fair value or amortised cost, depending on the measurement of the asset), financial guarantee contracts and commitments to provide a loan at a below-market interest rate (both measured at the higher of the amount accordance with IAS 37 or the
amount initially recognised less cumulative amortisation) (IASB,2013, 39.47)
After the initial recognition shall assess at the end of each reporting period whether there is any objective evidence that a financial asset or a group of financial assets is impaired. If there is any evidence of an impairment the entity have to determine the amount of the impairment loss. The determination of the impairment loss is different for each of the three measurement models mentioned above. For the assets carried at amortised cost the loss of the impairment will be the difference between the carrying amount and the present value of the estimated future cash flow discounted at the assets original effective interest rate. The loss shall be recognised directly in the profit and loss or through an allowance account (IASB, 2013, 39.63). If the assets carried at cost the impairment loss can be measured as the difference between the carrying amount of the financial asset and the present value of
estimated future cash flows discounted at the current market rate of return for similar financial asset (IASB, 2013, 39.66). If there is a decline in the fair value of an available-for-sale
financial asset, this decline have to be recognised in the other comprehensive income. When there is objective evidence that the assets is impaired the cumulative loss that is recognised in
the other comprehensive income shall be reclassified from equity to profit or loss (IASB, 2013, 39.67).
IFRS 9
With the publication of the Exposure Draft (ED) Financial Instruments: Expected Credit
Losses (hereafter ED 2013) of the new IFRS 9 regulation on impairments, the IASB wants to
resume the public discussion on the new impairment standard. ED 2013 is the second phase in a three step program of the IASB to replace IAS 39: Financial Instruments: Recognition and
Measurement with IFRS 9Financial Instruments. The IASB started in 2008 with the second
phase of the IFRS 9 standard, the impairment methodology (This will be defined as IFRS 9 from here on). The IASB published in 2009 the first ED for IFRS 9. After receiving comment letters, the IASB re-deliberated on the issue and published a supplementary exposure draft (S-ED) in 2011, to discuss operational concerns that were raised (IFRS, 2011). In 2013 the IASB published a second ED which included previous the feedback given on previous ED and S-ED. With the comments on the 2013 ED the IASB is starting is final deliberations and is expecting to publish the new standard in the middle of 2014.
IFRS 9 is considered to an industry-specific accounting standard. The influence of this new standard will affect the entity’s credit losses on financial assets (IFRS 2013b;EY, 2012). The main part of the new standard is to replace the incurred loss model with a more forward looking expected credit loss model (IFRS, 2013a). An entity will recognise expected credit losses as expected credit loss allowance or ‘loss allowance’ if those expected credit losses relate to a financial asset measured at amortised cost or a lease receivable. If the expected credit losses are related to loan commitment or financial guarantee contract then the entity should recognise a provision (ED/2013/3.3). At the reporting date the entity shall measure the expected credit losses for financial instruments at an amount equal to the 12-month expected credit losses (ED/2013/3.4) There are two exceptions on this (1) At the reporting date the entity shall measure the expected credit losses for a financial instrument at an amount equal to the lifetime expected credit losses if the credit risk on that financial instrument has increased significantly since initial recognition (ED/2013/3.5) and (2) the simplified approach for trade and lease receivables (ED/2013/3.12). These loss allowance measure for the receivable shall always be an amount equal to the lifetime expected credit losses. The basis for an estimation of expected credit losses will reflect (1) an unbiased an probability-weighted amount that is determined by evaluating a range of possible outcomes (2) the time value of money
(ED/2013/3.16). The unbiased probability-amount is just an estimation to reflect the possibility that a credit loss occurs or that it does not occur.
The interest revenue shall be presented in the statement of profit or loss and other comprehensive income as an separated line item. The calculation for the interest revenue will be done using the effective interest rate to the gross carrying amount of a financial asset. There is are two exceptions; when the financial asset is purchased or originated
credit-impaired, then the entity shall apply the credit-adjusted effective interest rate to the amortised cost from initial recognition. If the financial asset has objective evidence of impairment at the reporting date, the entity will use the effective interest rate to amortised cost of the financial asset in the subsequent reporting period (ED/2013/3.25).
The IFRS 9 standard as presented above is also seen as a 3 stage model which reflects the general pattern of deterioration until the financial instrument defaults. In the first stage the 12-month expected credit losses are recognised for financial instruments that have not
deteriorated significantly in credit quality since its original recognition or that have a low credit risk at the moment of the new reporting date. The interest revenue calculated for these financial instruments are measured at the effective interest rate on gross carrying amount.
In the second stage there will be expected loss recognition for financial instruments that have deteriorated significantly in audit quality since initial recognition. This is only applicable if the financial instrument does not have a low credit risk at the reporting date. The expected loss recognised for the financial instrument in stage two is done at the lifetime expected losses. The interest revenue is still calculated on the gross carrying amount.
At the final and third stage is the financial instruments have objective evidence of impairment at the reporting date. For these financial instruments the lifetime expected credit losses are recognised. The interest revenue calculation is different from the previous two stages, here the interest revenue is calculated using the effective interest rate on the amortised cost (IASB, 2013a). The three stages mentioned above are presented in a visual overview by the IASB in Table 2.
Table 2 three stage model of IFRS 9
Deterioration in credit quality since initial recognition
Stage 1 Stage 2 Stage 3
Recognition of expected credit losses 12-month expected credit losses Lifetime expected credit losses Lifetime expected credit losses
Interest revenue Effective interest rate on gross carrying amount
Effective interest rate on gross carrying amount
Effective interest on amortised cost carrying amount.
The information is form the Snapshot of ED/2013/3 made by the IASB (IFRS, 2013b)
Comparison
To see what the changes have been between the two standards first we look at the similarities that still exist. At first both standard use the same measurement method for measuring the interest revenue, by using the effective interest rate on gross carrying amount or amortised cost carrying amount. After reducing the amount of categories in the proposal there is still the possibility to measure the financial instruments at fair value through other comprehensive income and at amortised cost.
There are more differences between the current and the proposed standard. The main difference between IAS 39 and IFRS 9 is the change in loan loss model that has to be used. As presented above in IAS 39 companies have to use an incurred loss model, which say that it can only be used when there is objective evidence that a default has occurred within the financial instrument (ED, 2013/3). This model has the lowest boundary and the longest waiting time to recognize an credit loss on the loans (Gebhardt and Novotny-Farkas, 2011). With IFRS 9 banks can recognise credit losses earlier, by using the expected loss model. This model does not recognise the changes in the market interest rate. This lead to the point that the loan values do not reflect the true economic value (Gebhardt and Novotny-Farkas, 2011). With the Figure 1 shows a visual comparison between the incurred loss approach, the
Figure 1
Alternative Loan Loss Accounting Approaches and Regimes
(Figure is from Gebhardt and Novotny-Farkas (2011, p.296) based on the ED/2009)
2.4.
Hypothesis
One of the main trigger for the financial crisis was the housing bubble. Kanagaretnam et al. (2010) found that banks that hold more commercial and real estate loans bear a higher risk for default and therefor have to retain a higher LLP. The higher amount of commercial and real estate loans could be the cause for the financial crisis and could influence each other but this is beyond the scope of this article. Giner and Acre (2012) show that companies will
participate in the due process by lobbying to influence the standard-setter. Based on the interest group theory described previous, prepares will try to influence the decision making process of the standard-setters. With the case of the upcoming IFRS 9 standard, the change in preparing and calculating the LLP, the preparers (and other respondents) show their issues on the lifetime expected credit losses (IFRS 5c, 2013). One of the arguments presented by the respondents is that the recognition of the lifetime expected credit losses is highly subjective (IFRS 5C, 2013), which allows the managers to use more discretion in their calculations for the LLP. To see if entities that participate in lobbying already use more discretion, and by that meaning participate more in earnings management, in their financial reporting of LLP then companies that does not lobby. The hypothesis for this research will be
Hypothesis = Companies that react on exposure drafts through comment letters have higher discretionary accruals for loan loss provisions
In the next part the use of discretionary accruals will be further specified. There will also be show how the LLP is calculated and how this is linked to earnings management.
3.
Methodology and Data
3.1.Methodology
The LLP as used by companies in the financial industry exist of two elements. Those two elements are: the non-discretionary element and the discretionary element. The difference between these two elements are that the non-discretionary element shows the expectations that could reasonably be expected from normal business operations. The discretionary accrual is the part that is used for earnings management (Norden and Stoian, 2013). To measure the amount of discretionary accrual in the LLP, first the non-discretionary accrual have to be measured. To do this, this study will use the approach presented by Kanagaretnam et al. (2010) to measure the LLP. The residual of the regression model (1) are the discretionary accrual also described as the abnormal LLP.
LLP =ܽ+ܽଵBEGLLA +ܽଶBEGNPL +ܽଷCHNPL +ܽସLCO +ܽହCHLOANS + (1)
ܽLOANS + LOANCATEGORIES + YEARCONTROLS + ϵ
Where:
LLP = Provision for loan losses;
BEGLLA = Beginning loan loss allowance;
BEGNPL = beginning non-performing loans;
CHNPL = change in non-performing loans;
LCO = net loan charge-offs;
CHLOANS = change in total loans outstanding;
LOANS = total loans outstanding; and
LOANCATEGORIES = amount of commercial loans (COMM), consumer loans
(CON), real estate loans (RESTATE), agriculture loans (AGRI), loans to foreign banks and governments (FBG), and loans to other depository institutions (DEPINS)
As mentioned above the residual (ϵ) from model (1) is the abnormal component of the LLP, further in this research it will be described as ALLP. The expectation of BEGLLA is a negative coefficient, because when there are higher loan loss allowance in the beginning, the LLP for the current period will be reduced. As presented in prior research the coefficientܽଶ, ܽଷ,ܽସ, andܽare expected to be positive. When there are more non-performing loans in the
loan portfolio of entities, this would lead to a higher loan loss provision. For this reason the expected relation between LLP and beginning non-performing loans (BEGNPL) will be positive. For the change in non-performing loans (CHNPL) there is also and positive relation expected with LLP, because when the change is positive is positive the LLP has to increase to cover the losses in the current period. The net loan charge-offs (LCO) are expected to also be positively related to LLP. Kanagaretnam en al. (2010) explain this by referring to Beaver and Engel (1996). They say that the loan charge-offs have the possibility to provide information about future loan charge-offs, the loan charge-offs can influence the expectation of the collectability of loans. Because of the influence on the loans it will also influence the LLP. For the total outstanding loans (LOANS) there is a positive relation expected, because if entities have more loans outstanding than their has to be more taken in reserve for possible defaults, hence a higher LLP. For the change in total loans outstanding (CHLOANS) there is not a real prediction of the expected relation with LLP possible. This is due to the quality of the new issued loans.
The variables non-performing loans and the loan charge-offs already serves as an risk measure, there are six variables additionally added to control for differences in loan
composition that can influence the differences in risk. For example, as seen in the financial crisis, keeping real estate loans or loans to foreign governments (Greece) had a higher risk than keeping a larger part from the portfolio in consumer loans. The variables used for the loan portfolio composition in model (1) are all divided by the beginning total asset to
represent their share of the total assets. The six variables are the commercial loans (COMM), the consumer loans (CON), real estate loans (RESTATE), agriculture loans (AGRI), loans to foreign banks and government (FBG) and loans to other depository institutions (DEPNIS). To make sure there are nog period-specific effects there are year-indicator variables included in the model (1). These period-specific effects are representing the years 1998 till 2013.
Main test
To find out if there is a positive relation between the LLP (ALLP) and the lobbying participation through the use of comment letters than for financial institutions that do not participate in lobbying through comment letters. The variable LETTER is created as an indicator variable that equals 1 if a financial institution send in a comment letter and 0 otherwise. With the interaction of ALLP and LETTER this study tries to find the interaction between earnings management and lobbying through comment letters. The next model will
give an indication if ALLP can be an incentive to send a comment letter to the IASB to participate in the due process. The model (2) is estimated for both directions (positive and negative) to see if there is an interaction between LETTER and ALLP. For control on these factors the variables used are return on asset , company size, leverage, market-to-book ratio, loss of a company if any and the use of a big 4 auditor. The logistic model is:
LETTER =ߚ+ߚଵALLP+ߚଶROA +ߚଷSIZE +ߚସLEV +ߚହMTB + (2)
ߚLOSS +ߚBIG4 + ϵ
where:
LETTER = If companies respond with an comment letter;
ALLP = Abnormal loan loss provision (residual from model (1));
ROA = Return on asset;
SIZE = Size of the company at the end of the year;
LEV = Leverage of the company (total debt divided by total equity);
MTB = Market-to-book ratio at the end of the year; LOSS = the loss of company before extra items /preferred
dividends; and
BIG4 = if the financial institution have a big 4 auditor (PwC, Deloitte, KPMG, EY)
The coefficientߚଵis of interest in this model. A positive coefficient is consistent with that sending a comment letter is dependent of existing of abnormal loan loss provision. This would indicate that earnings management can influence the decision to engage in lobbying.
3.2.
Data
The data sample used in this research are the largest banks from WorldScope the data is collected through the use of DataStream for the years of 1998 – 2013. At first there is an initial sample of 7554 fiscal year observations. After removing duplicates the sample exist of 6943 fiscal year observations left for using in this research. Finally there are 2808 fiscal years observations left for ALLP logistic regression. The final samples includes both companies that did and did not individually respond on the invitation of the IASB to share their opinion on the new IFRS 9 standard..
The descriptive statistics of the scaled variables that are used in the regression are presented in table 3, Panel A. Note that for the ALLP just a sample of 2802 was available. The ratios for LLP, beginning non-performing loans and the loan charge-offs are,
respectively, 0.007, 0.03, 0.006. From the total sample is about 6.6% the share of the companies that individually responded to the IASB.
To make sure that there is no multi-colinarity between the control variables and the LLP a spearman test is performed (see table 3, Panel B). There is a positive correlation
between the LLP the beginning non-performing loans (BEGNPL), the loan charge-offs (LCO) and the change in non-performing loans (CHNPL). There is also a positive correlation
between the use of a big 4 auditor (BIG4) and the abnormal loan loss provision (ALLP)
Table 3
Descriptive statistics and correlation test
Panel A: desriptive statistics (n=6943)
variable mean sd p25 p50 p75 LETTER .0665418 .2492448 0 0 0 LLP .0072793 .0210225 .001457 .0039568 .0083415 ALLP (n=2808) -1.17e-12 .0085547 -.0033782 -.0012422 .0012838 BEGLLA .0220822 .0336208 .0080304 .0145468 .0265938 BEGNPL .035234 .4021293 .00693 .0177601 .035852 CHNPL .0035871 .6480729 -.0020904 .0001896 .0039793 LCO .0065729 .0624282 .0005688 .0020793 .0056819 CHLOANS .0999986 .7916913 .0067728 .0537697 .1308704 LOANS .7706973 .9893326 .6272182 .7354848 .8554467 COMM .1480133 .1955818 0 0 .3100212 CON .0755999 .2330156 0 0 .0844436 REALSTATE .100831 .5194603 0 0 .1168193 AGRI .1999851 .3716582 0 .0623507 .3072919 FBG .008804 .035575 0 0 0 DEPINS .0727065 .1352741 2.72e-06 .032306 .0943951 ROA .0085607 .0347641 .0034098 .0080708 .0140687 SIZE 1.879.886 2.879.111 167.401 1.862.319 2.097.931 LEV 3.249.063 1.848.855 .6276034 1.614.278 375.549 MTB 2.131.914 1.879.867 .8722769 1.367.756 2.070.824 LOSS .073748 .2613792 0 0 0 BIG4 .9177589 .2747515 1 1 1
LETTER 10000 LLP 0.0188 10000 0.3248 ALLP 0.0914 0.6546 10000 0.0000 0.0000 BEGLLA -0.0651 0.4709 0.1780 10000 0.0006 0.0000 0.0000 BEGNPL -0.1169 0.3386 -0.0562 0.6642 10000 0.0000 0.0000 0.0032 0.0000 CHNPL 0.0409 0.2438 0.0481 -0.0587 -0.2053 10000 0.0317 0.0000 0.0116 0.0021 0.0000 LCO 0.0458 0.4461 0.3439 0.3519 0.1710 -0.0358 10000 0.0161 0.0000 0.0000 0.0000 0.0000 0.0602 CHLOANS -0.0719 -0.0195 -0.0296 0.0037 -0.1671 0.0925 0.0079 10000 0.0002 0.3053 0.1205 0.8459 0.0000 0.0000 0.6770 LOANS -0.1617 0.1766 0.0055 0.1912 0.0886 0.0953 0.0862 0.5572 10000 0.0000 0.0000 0.7715 0.0000 0.0000 0.0000 0.0000 0.0000 ROA -0.0705 0.0225 0.0918 0.2075 -0.1192 0.0112 0.1328 0.4208 0.2299 10000 0.0002 0.2380 0.0000 0.0000 0.0000 0.5551 0.0000 0.0000 0.0000 SIZE 0.0456 -0.0991 -0.0909 -0.1501 0.0847 -0.1240 -0.0636 -0.1827 -0.2856 -0.3290 10000 0.0166 0.0000 0.0000 0.0000 0.0000 0.0000 0.0008 0.0000 0.0000 0.0000 LEV 0.2097 0.0150 0.1201 -0.1616 -0.3051 0.0981 0.0248 0.0466 0.0171 -0.1097 -0.0991 10000 0.0000 0.4308 0.0000 0.0000 0.0000 0.0000 0.1929 0.0145 0.3707 0.0000 0.0000 MTB -0.0303 -0.0271 0.1529 -0.0110 -0.2350 -0.0577 0.1310 0.3582 0.1896 0.5329 -0.2161 0.1278 10000 0.1112 0.1543 0.0000 0.5640 0.0000 0.0024 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 LOSS 0.0500 0.2592 0.1791 0.0701 0.1444 0.0985 0.0979 -0.2342 -0.0676 -0.4300 0.0420 0.0508 -0.2034 10000 0.0087 0.0000 0.0000 0.0002 0.0000 0.0000 0.0000 0.0000 0.0004 0.0000 0.0273 0.0076 0.0000 BIG4 0.0439 -0.0612 0.0460 -0.0081 -0.0639 -0.0475 0.0747 -0.0924 -0.0429 -0.0847 0.0371 -0.0380 -0.0342 0.0289 10000 0.0212 0.0013 0.0158 0.6703 0.0008 0.0126 0.0001 0.0000 0.0242 0.0000 0.0512 0.0457 0.0725 0.1287
The numbers below the correlation coefficient are the p-values See Appendix B for variable definition
Before we can see if there is a relation between abnormal loan loss provision and the use of lobbying we have to define the LLP. By using model (1) the ALLP is calculated as the residual. The residual will be used for further calculations. The estimated results from model (1) are presented in table 4. Table 4 show that for some of the coefficients the expected signs are significant, like BEGNPL, CHNPL, LCO and CHLOANS are significant at a 0.01 significance level. From the variables that define the loan portfolio composition only the DEPINS is significant. Against the expectations the CONM and RESTATE have a coefficient that changed signs, but the variables are not significant. The adjusted R² is 20.93% this is indicates that the model does not describe the change for LLP in the best way2.
Table 4
Regressions for Computing ALLP
Results of regression of LLP on Determinants of ALLP (n=2808)ª
Variable Expected sign Coefficient t-statistic
Intercept ? .0030 * 2.32 BEGLLA - -.0112 -1.09 BEGNPL + .0912 *** 12.79 CHNPL + .1247 *** 14.96 LCO + .0078 *** 3.12 CHLOANS ? .0069 *** 3.90 LOANS + .0001 0.06 CONM + -.0003 -0.15 CON ? .0005 0.24 RESTATE + -.0010 -0.50 AGRI ? .0026 1.24 FBG ? -.0039 -0.95 DEPINS ? -.0077 *** -2.79
Year controls yes
N 2806
Adjusted R² 20.93%
*,**,*** Indicate 0.10, 0.05 and 0.01 significance levels, respectively for a two-tailed test ª Regression model used:
LLP = ܽ+ܽଵBEGLLA +ܽଶBEGNPL +ܽଷCHNPL +ܽସLCO +ܽହCHLOANS +ܽLOANS + LOANCATEGORIES + YEARCONTROLS + ϵ
4.1.
Interaction ALLP and LETTER
The objective is to test whether the association between lobbying on the exposure draft, by sending a comment letter, and the abnormal LLP (ALLP) is stronger for banks that
2
Kanagertnam et al. (2010) find with this model in their research a R² of 66.32 percent, indicating that this measure is less favourable than previous research, but still higher then Ashbaugh et al. (2003) which has an R² of 18 %
participate in lobbying then for banks that did not responds on the invitation to comment on the exposure draft. The results for the expectation from model (3) are presented in table 5. Table 5 shows that there is a significant positive interaction between ALLP and LETTER (p-value < 0.01), this indicates that the use of abnormal loan loss provision and lobbying through comment letters have a positive relation. The leverage of a financial institution also have interaction with the participation in lobbying. This could become of the influence a standard can have on the financial ratios of a company. But the interaction between lobbying and the amount of leverage is something future studies. The control variable gives back a score of 0 because of the complexity and regulations all large financial institutions are depend on a big 4 auditor. This did not make any difference in the regression.
Table 5
Regression for interaction LETTERᵇ
Variable Coefficient Std. Err. z P>|z| [95% Confidence Interval]
Intercept -3.771047 .6123615 -6.16 0.000 *** -4.971253 -2.57084 ALLP 19.14774 7.161592 2.67 0.008 *** 5.11128 33.18421 ROA -3.675773 5.842019 -0.63 0.529 -15.12592 7.774373 SIZE .0492725 .0302465 1.63 0.103 -.0100095 .1085545 LEV .0614138 .0111155 5.53 0.000 *** .0396277 .0831998 MTB -.044837 .0533124 -0.84 0.400 -.1493275 .0596534 LOSS -.2703384 .3792734 -0.71 0.476 -1.013701 .4730238 BIG4 0 (omitted)
*,**,*** Indicate 0.10, 0.05 and 0.01 significane levels, respectively for a two-tailed test ᵇ The regression model is:
LETTER =ߚ+ߚଵALLP+ߚଶROA +ߚଷSIZE +ߚସLEV +ߚହMTB +ߚLOSS +ߚBIG4 + ϵ
4.2.
Additional analysis
Besides the empirical research to see if earnings management through abnormal loan loss provision has influence on the decision to lobby in the due process of the IASB, this study also look at the issues that are mentioned by the preparers and there representative groups in the comment letters on the ED/2013. According to (Mora and Molina, 2014) the prepares do not address all issues, but mainly react to the issues they are most against. With this additional analysis there is looked if there are main issues which are addressed by multiple preparers. For these main issues is looked to which extend they have influence on the valuation of loan loss provision. From al the financial institutions and there representative groups working globally, there are 56 entities that did respond through a comment letter on the ED of IFRS 9. The comment letters of these 56 entities will be used for the additional analysis.
Most of the preparers do support the ED/2013 or appreciate the effort (36 respondents or 64%), of the reaming 20 respondents there are 3 (5%) respondents who don’t agree with the IASB model for expected credit losses and there rest 17 (31%) did not agree or disagree with the model in the ED. As most of the prepares are supportive towards the ED they all still have some issues regarding the proposal and approaches within the ED.
For instance ING Group (Flynn, 2013)
“in our view, the proposals in this ED will still not achieve the intended purpose of revising the current loan loss provisioning requirements under IFRS” (p.1)
The reason that Flynn (2013) gives for this issue is because, in his view, the new loan loss provision should create a provision during the ‘good times’ and be addressed during difficult or ‘bad times’. Now is there only an increase in the provision but there is no way to use these higher provisions in an economic heavier period. Another objective behind the change in from the incurred loss model to an expected loss model, was to create a single impairment standard, with the same requirement under IFRS and US GAAP. The break-up between the IASB and the FASB in the later stadium of the due process is a burden for prepares that have to report under the US GAAP and the IFRS standard. Therefor a lot of the respondents that encourage the IASB to concur with the FASB and come to one impairment model. Besides the
operational burden that is created with this it also increase cost to prepare the disclosures. To get more specific responses on certain point of the proposal, the IASB prepares some question where the prepares can respond on (IFRS, 2013a). The question are stated to cover all aspects of the ED and the proposal. The majority of the responses has issues
presented in three questions. The issues related to the first question is that the responder do not agree or do not support that an approach that recognises a loss allowance at an amount equal to a portion of the expected credit losses initially, will reflect the economic link between pricing of financial instruments and the credit quality at initial recognition. The reason for this is that the expected losses are already reflected in the initial pricing and that it might distort the possibility to compare portfolios of different quality between entities.
However there are also companies that accept this approach and do not agree or support an approach that recognises a loss allowance at an amount equal to lifetime expected credit losses initially, will reflect the economic link between pricing of financial instruments and the credit quality at initial recognition. The reason these responders provide are that this
approach can lead to a day-one-loss which creates a front-loading of credit losses, the approach differs from the current practice and the complexity of forecasting lifetime losses. This un-alignment and front loading would not provide a sufficient cost/benefit balance.
The issues presented in the second question is that the prepares do not agree or support the proposed requirement to recognise a loss allowance (or provision) at an amount equal to lifetime expected credit losses on the basis of a significant increase in credit risk since initial recognition. This is for instance that the practice determine the provision rate on the based on credit risk level at the moment when the loss allowance is measured. The guidance which is provided by the proposal is sometimes not seen as adequate, because there multiple methodologies that can assess credit deterioration. The model chosen requires a comparison on the probability of default at origination and the probability of default at reporting date. This model is highly complex and very costly to implement.
The final question where the majority of the responders had an issue with some disclosures. Within the disclosure one of the issues presented by the prepares is the
presentation of the credit risk. This issue is also addressed in prior literature by Gaynor et al. (2011). They find in their research that only improving the disclosures does not mitigate misinterpretation of fair value for investors. They say that standard-setters even should consider to exclude credit risk gains and losses from the income statement.
Concluding the additional analysis the majority of the prepares do support the IASB model for expected credit losses. The issues are that are presented almost all have an
operational or economic motivation for an change in the current proposal. From an increased lead time to a not sufficient cost / benefit balance. These changes do not strongly indicate that the prepares are looking for ways to have more possibilities to influence the calculation of the loan loss provision. This could indicate that there is already enough possibilities in the current proposal or that by not responding to certain points could remove the attention from them. There is a general objective that is not covered by the IASB according to the preparers, that is the convergence with the FASB to publish one impairment standard.
5.
Conclusion
This study has the intension to find out if there is an relation between the participation in the due process and the use of earnings management through loan loss provision. In prior
research is show that the loan loss provision is the most used way for financial institutions to engage in earnings management (Nelson et al., 2002). The new standard for impairment of financial assets by the IASB gives good opportunity to look in this relation. Because with a
change from the incurred loss model in IAS 39 to an expected loss model in IFRS 9. This has an influence on the loan loss provision, this will be due to the effect of the three stages that are presented in the latest proposal (IFRS, 2013a)
The participation in the due process by prepares can be done by using a direct and/or an indirect method (Orens et al., 2011). The benefits of the different methods are depending on the impact they have on the future cash flow of the preparer (Orens et al., 2011). In line with prior research, this research focus on the use of comment letters to get more insight in the use by preparers. The preparers and representation groups for prepares that did respond through a comment letter on the invitation of the IASB to respond on the ED/2013 are used as data sample to see if the relation between earnings management and lobbying through
comment letters does exist.
In the regression is shown that there is a 0.01 significance level for the interaction between abnormal loan loss provision and the participation of lobbying in the due process of the IASB. This indicates that companies that participate in lobbying engage in earnings management through loan loss provisions. There are some limitations of the data sample that is used for companies that lobby is relatively small, this due to the part that a large group of financial institutions respond through their association. The members of these association are difficult to track down and reduces the ability to use them in the data sample.
Within the additional analysis there is looked at the issues that are presented by the prepares and the representative groups. This analysis revels that the majority (64%) of the prepares do support the expected loss model presented by IASB for the impairment on financial assets. The issues are mostly done based an operational or economical motivation from the prepares, but the issues they present do not strongly indicate that the prepares are looking for ways to have more possibilities to influence the calculation of the loan loss provision.
A.
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