The qualitative characteristics of financial information, and managers’ accounting decisions: evidence from IFRS policy changes

Abstract

This is the first empirical study that uses publicly available data to provide direct evidence about the role of the qualitative characteristics (QCs) of financial information in managements’ accounting decisions. Based on 40,895 hand-collected IFRS (International Financial Reporting Standards) policy choices on 16 topics made by 514 large firms of 10 jurisdictions in the period 2005–2011, we identify 204 reasons for policy changes. The majority of these refer to QCs from the conceptual framework of the standard-setter, in particular to relevance, faithful representation, comparability and understandability. Firms also frequently refer to transparency, which is not directly mentioned in the framework. Furthermore, we analyse the circumstances under which firms explain their policy changes in terms of improved quality. We hypothesise and find that QCs are more often referred to if the change relates to measurement (i.e. to a more important accounting policy decision). We also find that references to QCs are positively associated both with firm size and with a measure of a jurisdiction's transparency. This complements previous research by providing evidence that managers are, at the least, alert to QCs.

Keywords:

• qualitative characteristics
• IFRS
• relevance
• faithful representation
• comparability
• understandability
• transparency

JEL Classification:

• M41

Acknowledgements

The authors are grateful for comments from Mary Barth, Vivien Beattie, Jürgen Ernstberger, Richard Macve, Brian Singleton-Green, Steve Young, Stephen Zeff, Na Zhao, Ann Tarca (the guest editor), two referees of this journal and workshop participants at the 2014 British Accounting and Finance Association Annual Conference, the 2014 European Accounting Association Annual Congress and the Inaugural IASB Research Forum in 2014, especially Niclas Hellman (the Academic Commentator) and Mary Tokar (the IASB Commentator). They are grateful for historical documents from Martin Persson and research assistance from Shiyun Song and Guojing Tang.

Disclosure statement

No potential conflict of interest was reported by the authors.

Funding

Financial support was provided by the Department of Accounting and Finance at Lancaster University Management School.

Notes

1. Of the 16 topics in Table 1, on which there was overt choice in IFRS in 2011, there was no overt choice in US GAAP for topics 5, 8, 9, 10, 11, 13 and 16. We are not aware of other major topics on which there was choice in US GAAP but not in IFRS.

2. One of these jurisdictions is Hong Kong. Despite this, for simplicity, we refer to ‘countries’ hereafter.

3. Macve (2015) is an example of papers which discuss accounting over that span.

4. In the case of the 1844 Act, the compulsion was limited to sending an annual balance sheet to the shareholders, and this requirement was repealed in 1856, not to return until the twentieth century.

5. In 2013, the Directive was revised. The six principles were retained, but more were added.

6. Nobes (1983) records that the first four were to be found in the UK's Statement of Standard Accounting Practice No. 2 (Disclosure of Accounting Policies) of 1971; and that going concern and accruals had not been in the 1971 draft, before the UK joined the ‘Common Market’ in 1973.

7. The documents were published by the AICPA, but the Director of Accounting Research (Maurice Moonitz, an academic) notes that publication was ‘under his authority’. The first was written by Moonitz; the second by Robert Sprouse (another academic) and re-drafted by Moonitz.

8. The word ‘standards’ in its current meaning appears to have originated in the UK with the foundation of the Accounting Standards Steering Committee in 1969 (Rutherford 2007, p. 37).

9. Stephen Zeff (in a letter of 7 August 2014) notes that there is no evidence of this in the minutes of the Board's meetings, but the Framework was always included in the IASB's annual books of documents.

10. Concepts Statement No. 8 of 2010 replaced Concepts Statements No. 1 and 2.

11. That is, it is not part of IFRS. It can be inconsistent with parts of IFRS. In the EU, it is not part of the endorsed content of IFRS.

12. By definition, the first type is extremely rare. For the second type, IAS 8 does not specify any disclosures.

13. IAS 8.23 allows an exception when that is ‘impracticable’.

14. Materiality is an aspect of relevance (IASB 2010, QC11), so there should not be disclosures of the existence of immaterial changes. Therefore, the disclosure of a change implies that it is material and should therefore be explained. Despite this, in our data, there are nine cases of disclosed but unexplained changes which were said to have no material effect.

15. In the IASB's ‘bound volume’ of standards for 2011 onwards, footnotes have been added to IAS 1 and IAS 8 which mention that a revised Conceptual Framework has been issued, but these footnotes have not been through ‘due process’ and are not in the EU-endorsed or the Australian versions of the standards (EU countries and Australia comprise 6 of the 10 countries in our empirical analysis).

16. For example, the UK's Local Authority Pension Fund Forum and other investors commissioned a legal opinion (from G. Bompas QC, dated 8 April 2013) which cast doubt on the legality of IFRS for various reasons, including the removal of prudence.

17. These are the topics included by Kvaal and Nobes (2010). It would be possible to identify a few more. For example, André et al. (2012) appear to have 25. However, several of these are not really policy choices, such as depreciation method (which an entity is supposed to identify rather than choose) and whether or not segment information is disclosed. As a footnote to Table 1 explains, two options were removed for 2009 onwards. Additionally, there was no choice in Australia for topics 7 and 16 for accounting periods beginning before 1 July 2007. It would be possible to argue that some of these topics are really matters of estimate rather than policy, such as topic 14 on inventory costing. However, the strong association of policy with country (Kvaal and Nobes 2010) suggests that choice is involved.

18. We will find references to QCs unless one of the following three conditions applies to all of the policy changes that we analyse: first, the policy change falls outside the scope of the requirement to provide an explanation for improved relevance; for example, early adoption of a new or amended standard (see IAS 8.20); or, second, the firm does not comply with the requirement to explain (IAS 8.29) or, third, the firm provides a reason but it is not a QC.

19. That is, we use the constituents of the main stock market indices on 31 December 2005 or 31 December 2010 or both: S&P/ASX-50 (Australia), SMI (Switzerland), Hang Seng China Enterprises Index (China), DAX-30 & 10 largest (by market capitalisation) constituents of MDAX-50 (Germany), IBEX-35 (Spain), CAC-40 (France), FTSE-100 (United Kingdom), Hang Seng (Hong Kong), (S&P/MIB-40) FTSE/MIB-40 (Italy) and FTSE/JSE Top 40 (South Africa).

20. Although China has not fully adopted IFRS, the majority of the largest listed Chinese firms prepares IFRS financial statements, because they are listed on the Hong Kong Stock Exchange (HKEx), which required IFRS from 2005 to 2009. Consequently, Chinese firms with a listing in Hong Kong and Mainland China prepared two sets of financial statements (IFRS and Chinese GAAP). However, from 2010, HKEx accepts Chinese GAAP financial statements, and six firms in our sample have stopped preparing IFRS financial statements.

21. The proportion of IFRS policy changes to total choices differs significantly across the 10 countries (based on a χ² test of independence: χ² test statistic = 19.57, p-value = 0.02).

22. Our sample comprises 261 firms which made one or more policy change, and 253 firms which made no change. We do not find statistically significant differences in firm size, leverage and profitability between the two types of firms (policy changers and not), using two-sided t-tests and data from 2005 (or the first available year if a firm has not yet been listed in 2005); the means (p-values) for the variables SIZE, LEVERAGE and PROFITABILITY are 15.917 vs. 16.015 (0.34), 0.001 vs. −0.008 (0.60) and −0.004 vs. −0.001 (0.60), respectively. See Appendix 3 for the definitions of the variables.

23. When we repeat the analysis described in the previous footnote for the two types of firms (explanation providers and not), we do not find statistically significant differences in firm size, leverage and profitability. The means (p-values) are 15.985 vs. 15.960 (0.84), 0.002 vs. −0.005 (0.71) and −0.006 vs. −0.001 (0.50), respectively.

24. The proportion of IFRS policy changes which are explained does not differ significantly across the 10 countries (based on a χ² test of independence: χ² test statistic = 10.02, p-value = 0.35).

25. Both authors each did the entire scoring.

26. It could be argued that ‘better understanding of our business’ refers to faithful representation. However, neither ‘faithful representation’ nor any reference to better presentation of information is explicit in this explanation. Our coding is based on an objective approach as described in Appendix 2.

27. IAS 8.29 does not specifically include the word ‘material’ but IFRS requirements do not apply unless amounts are material (IAS 1.29 and IAS 8.8).

28. This matter was considered by the IFRS Interpretations Committee in September 2014 (Staff paper, Agenda ref 12D).

29. Of these 111, all but one reference is to QCs found in the 1989 version; the one exception is a reference to verifiability.

30. We do not attempt to distinguish between comparability and uniformity (see e.g. Macve 2014).

31. We consider the ‘comparability local GAAP’ reason to be different from standards driven reasons. Of the 14 cases, 10 are about topic 16, and all changes were from proportionate consolidation of joint ventures to the equity method. However, in 2011 three Chinese firms still used proportionate consolidation, including Air China, which is a state-owned enterprise. We would not observe such varied practice if there were a local requirement.

32. The sum of 56% and 24% is less than 100% because some of our topics allow more than two options (see Table 1).

33. The results are similar when we use a narrower definition of industry peers: that is, when we use other firms in our sample which have the same first two/three/four digits of the ICB code, the numbers are 58% vs. 22% (12 out of 16), 57% vs. 25% (12 out of 16) and 56% vs. 23% (12 out of 16), respectively.

34. The firm-year observation with the most changes is International Power in 2011 with six changes.

35. There are 257 firm-year observations with one policy change, 56 observations with two changes, 8 observations with three changes, 1 observation with four changes and 1 observation with six changes.

36. The variable PROFITABILITY_t−1 has an extreme observation and is therefore winsorised at the 1st and 99th percentiles.

37. Our results are robust to using industry medians instead of means for the adjustment.

38. The sample includes 248 firms: 179 firms with one firm-year observation (i.e. year with at least one policy change), 63 firms with two observations and six firms with three observations.

39. It tests the null hypothesis that the coefficients of all variables of the respective set are equal to zero. Our Wald tests are based on the coefficient estimates and standard errors of the logistic regressions, not the marginal effects and corresponding standard errors.

40. All of our topic variables are either about measurement or presentation.

41. The following proxies for a country's legal enforcement are also not statistically significantly related to references to QCs: ‘rule of law’ from Kaufmann et al. (2009) and both the audit and enforcement proxies from Brown et al. (2014); we use the 2008 scores and the marginal effects (z-statistics) are −0.013 (−0.46), −0.002 (−0.38) and 0.006 (1.06), respectively.

42. Our sample comprises the largest firms in our 10 countries, but there is substantial variation in firm size in our regression sample: the smallest and largest firms have a market capitalisation of $0.7bn and $220bn, respectively. Additionally, every country has at least one firm with a market capitalisation below $4bn and at least one firm with a market capitalisation above $37bn.

43. For a set of dummy variables where one dummy is selected as the reference group, the significance of any individual dummy depends on which dummy serves as the reference. Whether or not the entire set of dummy variables has an effect on the dependent variable has to be evaluated via a Wald test, which yields the same result regardless of which dummy serves as reference.