The European IFRS experiment: objectives, research challenges and some early evidence

Abstract

This paper provides an academic perspective on the development of the EU's harmonisation project based on International Financial Reporting Standards (IFRS), on the costs and benefits of IFRS adoption in Europe, and on the research challenges that arise. The paper reviews the accumulating academic evidence, emphasizing the effectiveness and transparency of the enforcement framework, and documenting the main lessons to be learned from the research programme on EU IFRS implementation conducted within the INTACCT network. Results on the consequences of IFRS adoption and the quality of implementation are far from uniform across Europe, and depend on factors reflecting preparer incentives and the effectiveness of local enforcement. The paper also outlines a possible alternative proposal for the organisation and development of enforcement activities in Europe.

Keywords:

• IFRS; IASB; harmonisation; incentives; enforcement; policy relevance

Acknowledgements

We are grateful to an anonymous reviewer of the paper and we acknowledge financial assistance from the European Commission INTACCT Research Training Network (MRTN-CT-2006-035850).

Notes

Note that the Constitution includes one further objective: ‘In fulfilling the objectives … to take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings’ (IFRS Foundation 2010).

Daske et al. (2009) use the term ‘label adoption’ when describing low quality adoption of IFRS.

The EEC objectives also included the free movement of persons, and goods and services.

For example, the Seventh Directive on Group Accounts provides options in the treatment of the definition of a subsidiary; exemptions from consolidations for parents that are not limited companies; exemptions where the ultimate parent is a non-EU company; exemptions for financial holding companies; the use of different valuation methods across the group; the use of proportional consolidation; and the immediate write-off of goodwill to reserves. See Roberts et al. (1996).

Pre-dating the Lisbon Conclusions, the Financial Services Action Plan and the Commission's Communications on Financial Services and Risk Capital had both called for the development of deep and liquid European capital markets to benefit both issuers and investors.

See Finance Director Europe, 1 September 2005.

On 1 January 2011, the Committee of European Securities Regulators (CESR) was replaced by the European Securities and Markets Authority (ESMA).

Ball et al. (2003) and Barth et al. (2008) are two key studies which, in motivating their research, set out the policy implications for regulators internationally.

For example, Dargenidou et al. (2006) consider cost of capital estimation from expected earnings growth during the initial stages of accounting regime change in Europe towards IFRS, conditioned by the quality of financial reporting at the firm level in terms of transparency and disclosure. See also Daske (2006) on the relations between accounting numbers and the estimated cost of equity capital at the time of initial IFRS adoption.

This ignores the possibility of conducting ‘laboratory’ experiments based on simulated market environments. Such experiments, while potentially insightful about aspects of human decision-making, are severely limited in their ability to capture the complexity of real financial markets comprising multiple interacting economic and legal institutions.

While elimination of this ambiguity is a considerable challenge to researchers, the existence of this ambiguity could work in the favour of policymakers, who might be able to claim credit for outcomes that would have occurred anyway.

See also Hail et al. (2010) on the potential adoption of IFRS in the USA.

There have been just four such notices since 2007. Where companies are asked or encouraged to make prior year corrections following a Panel enquiry, the Panel sometimes asks for a reference in the note explaining the correction and mentioning the discussions with the FRRP. As a result of the less consistent issuance of press notices in recent years, the influence of the FRRP on UK financial reporting is now less transparent, at least to the researchers. Even before 2007, researchers were handicapped in being unable to identify the full set of firms that were subject to FRRP investigations, from which the set of known adverse rulings were drawn. See, for example, Peasnell et al. (2001).

Another approach can be found in Qu and Zhang (2008), who explore the use of fuzzy clustering analysis based on a broad set of accounting items to characterise the degree of convergence between national GAAP and IFRS.

Private sector analysis such as Company Reporting also documents evidence on apparent non-compliance based on public information on a case-by-case basis.

Given space constraints, the discussion is far from a comprehensive review of INTACCT research output. Further information on published INTACCT research and working papers can be found at www.intacct-research.org

Ding et al. (2007, 2009) discuss the identification of IFRS–local GAAP differences and document considerable country-level variation in differences.

Ali et al. (2010) also examine loan-loss provisioning behaviour for a sample of Bulgarian banks.

INTACCT working papers are normally available as pre-publication drafts at: www.intacct-research.org/papers_wp/