The Negative Effects of International Financial Reporting Standards

A recent study shows that adopting International Financial Reporting Standards (IFRS) does not improve reporting quality among private companies. This research analyzed Italian private (i.e. non-listed ) companies that voluntarily switched to IFRS, providing evidence that their adoption lead to a decrease in reporting quality.

Mara Cameran, Angela Pettinicchio (Department of Accounting) and Domenico Campa (Trinity College Dublin) are going to publish IFRS Adoption among Private Companies: Impact on Earnings Quality in Journal of Accounting, Auditing & Finance (forthcoming).

The European Union introduced a common set of accounting standards in 2005, mainly to enhance financial reporting quality for all public companies. At the same time, though, EU gave the opportunity to each Member State to oblige or allow non-listed companies to use IFRS. Reporting quality is influenced by accounting standards, but the impact of IFRS has not clearly been defined yet. Therefore, the authors of the present study decided to understand whether the level of earnings quality is different between non-listed companies adopting IFRS and those firms still reporting under local GAAP. They selected for the empirical analysis Italian companies which switched to IFRS from 2005 to 2008.

The results show not only that IFRS adopters do not have higher earnings quality compared to national GAAP adopters, but also that those companies exhibit higher levels of abnormal accruals and a decrease in timely loss recognition. These findings suggest, according to the authors, that the adoption of a set of accounting standards reputed to be of better quality than the national ones does not imply per se a better financial reporting quality. The present article, however, goes even further in investigating this issue. The authors analyzed the data distinguishing between firms controlled by listed companies (the subsidiaries) and other firms. Subsidiaries, in fact, can adopt IFRS for complying with parent company requirements and/or simplifying the financial reporting process. The results provide evidence that reporting quality does not improve for neither group of firms, even if the impact of IFRS on earnings quality is worse, in some cases, for subsidiaries of listed companies.

Overall, the evidence provided by this study is of particular interest for the EU Commission in evaluating the impact of the current financial reporting regulation. Moreover, standard setters and regulators are asked to take into account the effects and consequences of the standards they develop or suggest. Therefore, EU national regulators should consider these results as well, given the degree of flexibility in endorsing parts of the European legislation. To conclude, this study provides a useful guidance to policy makers willing to better assess the consequences of International Financial Reporting Standards.