Have IFRS Affected Earnings Management in the European Union?

Abstract

There has recently been considerable discussion of those features of IFRS that are likely to help improve financial reporting in the European Union. However, certain issues may also have a negative impact on the quality of information. This paper focuses on the effect of IFRS on earnings management. Its main purpose is to examine whether the adoption of IFRS in the European Union has increased or decreased the scope for discretionary accounting practices by comparing discretionary accruals in the periods preceding and immediately after the regulatory change. Another objective is to determine which firms' features and country factors may explain the accounting discretion observed before and after IFRS. We consider a sample of non-financial firms listed on 11 EU stock markets. The results obtained show that earnings management has intensified since the adoption of IFRS in Europe, as discretionary accruals have increased in the period following implementation. The variables explaining accounting discretion are the same before and after IFRS (business size, leverage, investor protection and legal enforcement). These results suggest that variations in earnings management might be due to some room for manipulation under international standards when compared with local standards.

Acknowledgements

We acknowledge the editor, Peter Walton, and two anonymous reviewers for many useful comments and suggestions.

Notes

The IFRS model is considered to be close to Anglo-Saxon accounting systems, which have traditionally been considered less uniform than Continental European accounting models. However, some studies have shown that accounting practices adopted by firms are not always more uniform in European Continental countries. For example, Feige (1997) compares the degree of uniformity of corporate reports of British and German groups with regard to foreign currency translation, and argues that accounting practices of British firms are more uniform than German practices.

A comment on the strengths and weaknesses of the main accruals models, and specifically about Jones's model and its extension can be seen in Ye (2007).

This method has been used in numerous papers, including Wang (1994), Hall and Stammerjohan (1997), Han and Wang (1998), Erickson and Wang (1999), and Arcas and Vidal (2004).

This was done to gain a more nuanced analysis of the Wilcoxon test ranks, since it was possible that the result would show a larger number of positive (negative) ranks but the mean increment in the discretionary accruals made by the positively ranked firms would at the same time be lower (higher) than the mean decrease in the discretionary accruals made by negatively ranked firms.

Other institutional variables which could have been introduced for the model are real estate concentrations, importance of the stock market or accounting tradition. They were ruled out due to their high correlation (above 70%) with the variables eventually chosen.

In the level of earnings management, variables related with corporate governance will have influence, as shown in the papers by Beasley (1996), Dechow et al. (1996), Klein (2002), Leuz et al. (2003), Xie et al. (2003) and Peasnell et al. (2005).

Whittington (2008) points out that in as much as the enforcement of the standards may vary significantly across countries, the quality of IFRS financial reports is not comparable.