Standards, Management Incentives and Accounting Practice – Lessons from the IFRS Transition in Sweden

Abstract

The process of preparing financial statements gives rise to numerous accounting choices. Understanding these choices is critical for an understanding of accounting practice. The 2005 transition to IFRS in Europe provides a unique opportunity for studying the forces and factors that shape accounting practices. Based on empirical data from a series of in-depth interviews focusing on the choices and problems listed companies faced in the transition to IFRS in Sweden, we suggest that it may be appropriate to enrich the accounting policy choice literature by recognizing a wider spectrum of management incentives and available alternatives when making accounting policy choice decisions. In particular, we suggest that it may be fruitful to explore the role of incentives arising from the management control function. Our findings underline the importance of addressing how management incentives shape accounting practices and hence influence the outcome of the IFRS transition. They also suggest that a better understanding of the relationship between standards, incentives and actual accounting practices requires distinctions of different degrees and aspects of compliance.

Acknowledgements

We thank Peter Walton (the editor) and two anonymous reviewers for their helpful comments and suggestions. We are also grateful to participants at the 3rd EUFIN conference in Cergy, France, in September 2007. Furthermore, we thank Stuart Turley for providing helpful comments on an earlier version of this paper.

Notes

In this paper the term IFRS is used to denote (a) International Financial Reporting Standards (IFRSs), (b) International Accounting Standards (IASs) and (c) Interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) or (d) the former Standing Interpretations Committee (SIC).

Models which are not based on such comprehensive rational choice assumptions include, for example, the accounting model view (choices are made using accepted models), the innovation diffusion view and the garbage can model of organizational decision view (Ball and Foster, 1982 in Taylor and Turley, 1986, p. 98). More recently, Touron (2005) has argued that (new-)institutional theory can effectively explain the emergence of different accounting forms. Under this framework management practices – including accounting policies – may be used because they are socially legitimized.

Although this case is about disclosure policy rather than choice of accounting method, it has been included. The reasons for this are that the interviewees brought it up as a problem encountered in the transition to IFRS and it was handled in a way that shares some characteristics with the other problems and thus contributes to the understanding of the role of management incentives in this context.

Relevant in this case is also that the companies previously tended to provide fair value disclosures on a voluntary basis, thus reducing the perceived additional costs of that option.

In addition, most interviewees indicated that the switch from amortization to impairment testing of goodwill had required a lot of hard work. The general impression, however, was that this in itself had not given rise to serious concerns.

This is because the previous national standard-setter had, for a considerable number of years, applied a strategy of more or less translating IASs into Swedish recommendations. Companies listed on the Stockholm Stock Exchange were required to apply (or explain why they hadn't) these recommendations by virtue of the listing agreement.

In Sweden the enforcement requirements in the Transparency Directive were implemented from 1 July 2007. The interviews were conducted in the summer of 2006. At that time, a private sector review panel was in place.

Shortly after the interviews were undertaken the enforcement body in Denmark ruled that a Danish construction company was wrong to apply IAS 11 for similar types of transactions and that IAS 18 should have been applied. In July 2007 IFRIC published a draft interpretation (D21 Real Estate Sales) with guidance on how to make this distinction. Although the interviews suggested a growing awareness that the application of the percentage of completion method/IAS 11 might not be appropriate for all housing contracts, it remained unclear during the interviews whether management had been aware of this potential exposure to challenges of compliance at the time of transition to IFRS.

Previously some companies seem to have made a similar adjustment on a judgment basis looking, for example, on the level of pre-bookings.

One reason contributing to this might be that IAS 39 was not addressed in the interviews. Anecdotal evidence indicates that this is an area where firms have stopped or restructured certain transactions, for example, no longer hedging certain transactions due to hedge accounting rules.