IFRS adoption and financial statement readability: Korean evidence

Abstract

Accounting is often called a language of business and the grammar of the language is now under transition to a new one – the IFRS. Does the IFRS regime help make accounting a better business language than do other accounting regimes? That is our research question, and to answer the question we examine the effect of IFRS adoption on readability of firms’ financial disclosures. As a global accounting regime, the IFRS puts greater emphasis on understandability in financial reporting than do any other existing accounting standards. In many countries, however, adopting the IFRS involves the process of translating the original IFRS into local non-English languages, and apparently, the IFRS Foundation sticks to word-for-word or literal-translation policy to ensure an adopter country’s complying with the original IFRS. Understandability and literal translation, however, might be less than a good match. It is, therefore, timely and relevant to examine whether financial statement understandability has improved under the IFRS regime in non-English speaking settings. Korea serves as a real-world setting for research on readability of accounting information because Korea has two concurrent accounting regimes for two years before her complete IFRS adoption. We compare the 57 IFRS adopter firms and 943 non-such firms for readability of their disclosed financial statement footnotes. The univariate and multivariate results indicate that the IFRS-based financial statements have significantly lower, not higher, readability than those based on the local accounting standards. Results also show that minority shareholder population and firm age have significantly positive influence on the association between IFRS adoption and financial statement readability. The findings of this study have both academic and policy implications.

Keywords:

• IFRS
• understandability
• word-for-word translation
• financial statement footnotes
• translation policy

Acknowledgments

The authors would like to thank the participants in the Korean Accounting Association’s 2012 Winter International Conference held at Seoul National University, Seoul, Korea; the Korea International Accounting Association’s 2013 Spring Conference held at Kunsan National University, Kunsan, Korea; and the Japan Association of International Accounting Studies’ 2013 International Conference held at Chuo University, Tokyo, Japan for their helpful comments on this paper.

Notes

1. In the Conceptual Framework for Financial Reporting section, the IFRS characterizes relevance, predictive and confirmatory value, materiality, faithful representation, substance over form, prudence, and neutrality as fundamental qualitative characteristics and; comparability, verifiability, timeliness, and understandability (the author’s emphasis) as enhancing qualitative characteristics.

2. Currently, some 100 countries, including Argentina, Australia, Brazil, China, the EU, France, Germany, India, Indonesia, Italy, Japan, Mexico, Korea, Russia, Saudi Arabia, South Africa, Turkey, UK, and US have adopted the IFRS as a single or as an alternative accounting regime.

3. The Chairman’s Letter covers a wide range of topics including financial and nonfinancial operating results (Schroeder and Gibson 1990).

4. The IFRS Foundation is an independent, not-for-profit organization working in the public interest. One of its principal objectives is to develop a single set of high-quality, understandable (the author’s emphasis), enforceable, and globally accepted international financial reporting standards (the IFRS) through its standard-setting body, the IASB.

5. As of the time of this study, the number of Korea’s publicly listed firms, both on the KOSPI and the KOSDAQ combined, is 1767.

6. Hangul, the Korean alphabet, is a separate script from Hanja, the logographic Chinese characters which are also sometimes used to write Korean. It was created in the mid-fifteenth century, and is now the official script of both North Korea and South Korea and is co-official in the Yanbian Korean Autonomous Prefecture of Jilin Province, People’s Republic of China. Hangul is a true alphabet of 24 consonant and vowel letters. However, instead of being written sequentially like the letters of the Latin alphabet, Hangul letters are grouped into blocks, such as 한 (han); each of these blocks transcribes a syllable. That is, although ‘한’ may look like a single character, it is composed of three distinct letters: ‘ㅎ’ (h), ‘ㅏ’ (a), and ‘ㄴ’ (n). Each Hangul block consists of two to five letters, including at least one consonant and one vowel. These blocks are then arranged either horizontally from left to right or vertically from top to bottom (Wikipedia).

7. We use the following Heckman’s first-stage model to get inverse Mills ratios or IMRs by calculating log[p/(1 − P)], where p is the expected probability for each firm to early adopt the IFRS. IMRs are again included in the Heckman’s second-stage model to remove any potential self-selection bias.

IFRS_i = β₀ + β₁FirmSize_i + β₂LEVERAGE_i + β₃ROA_i + β₄BIG4_i + Σ_J = 1¹⁴β_4+KSIC_ki + ε_i.

where the definitions of the dependent and the control variables are the same as in the main text.

8. As for validity of readability scores as understandability measure, Jones (1994) also advises extreme caution when using readability formulas. Jones emphasizes the need for further research to assess the exact relationship between readability and understandability.

9. A good such example is the famous remark made by the French thinker Des Cartes: I think. Therefore I am (DuPree 1985).

Additional information

Funding

Funding. This work was supported by the National Research Foundation of Korea grant funded by the Korean Government [NRF-014S1A5A2A01013931].