Advanced Financial Reporting and Regulation

Introduction

The primary focus of the paper is to discuss International Financial Reporting Standards (IFRS).The article will highlight the significant characteristics of this standard with a special emphasis on its utility in the current business scenario. It has been reported that more than 140 countries have been using this framework to communicate their financials effectively. These firms are mostly publicly listed firms. Due to its vast application, the framework has been used globally as the standard for financial reporting. In this context, the paper will analyze the advantages and drawbacks, which persist while the companies try to adopt IFRS for their commercial reporting purposes. The analysis of benefits and disadvantages will be supported by theoretical approaches and empirical works. Despite the vast application of the framework, many companies are reported to have altered their financial statements to present a misleading picture of their financials in front of the stakeholders and the customers. This process is referred to as earnings management, which would be widely elaborated in the last section, along with its effect on IFRS.

Body

International Financial Reporting Standard (IFRS)

International Financial Reporting Standard (IFRS) is a standardized framework of financial reporting which contains a standard set of rules to guide the companies. These rules and regulations stipulated in IFRS ensure that financial statements of companies are consistent, transparent as well as comparable all across the world. The IFRS was first laid down by the International Accounting Standards Board (IASB). Through the usage of IFRS, the companies can ensure that they maintain their transaction accounts in a proper way to present them in their financial statements (Ben Othman and Kossentini 2015). The companies should abide by the regulations stipulated in IFRS to bring in accountability, transparency, and efficiency in the financial markets all over the world. Therefore, IFRS served as a common accounting language that helps the investors and the stakeholders in judging the marketing position of the company before making any investment decision (Sakaki et al. 2017). Transparency in the business practices helps in providing an accurate and complete picture of the company’s financials in front of the stakeholders such that either party can be benefitted. IFRS has been considered superior to GAAP as the adoption of IFRS has been considered cost-friendly as it excludes duplicative accounting works.

Benefits of IFRS (with theoretical models and empirical works)

The international financial reporting standard is a widely used framework, which binds all the financial statements of the companies in a universal set of regulations related to financial reporting. The companies suitably adopt this framework to be recognized in the global marketplace. Through the adoption of IFRS, the companies can easily access the world capital markets, which can be a platform for better promotion of their business. The company can easily compete in the global marketplace and be recognized as an international player in the market (Wadesango et al. 2016). The framework will give rise to a common financial reporting basis for the companies. The companies can apply this basis for setting up a common accounting standard for its subsidiaries all around the world. This would consequently enhance the communications between the parent company and its subsidiaries, which would be useful for improving the quality of reporting and decision making of the groups.

IFRS also helps in creating a standard benchmark for the company such that it can compare itself with its competitors in the market. This would also allow the investors and shareholders to compare the performance of the company in the global phenomenon, such that they can make wise decisions regarding investment. IFRS also helps the economy by driving the activities of international business (Bassemir and Novotny‐Farkas 2018). The investors can have a better and realistic view of the financial statements, which are prepared under a standard set of regulations, in contrast to other financial statements, which are made using a varied collection of accounting standards. Cross-border activities were eased up with the help of the IFRS framework (Collins et al. 2017). Previously, the transnational movements were complicated due to the presence of variable accounting standards, which added cost, complexity, and risk to the process. A common law of accounting abolished all these issues of cross-border activities.

Empirical research has been conducted to analyze the influence of IFRS on the quality of financial reporting, specifically in the listed companies of a developing country. The analysis has been carried out by Wadesango, Tasa, and Milondzo. The study was based on a mixed research approach through the application of questionnaires and unstructured interviews. Through the results, it has been observed that IFRS does not promote the activity of earnings management, through which the companies fabricate their financial statements to present a misleading picture in front of the stakeholders (Kim 2016). Through the application of IFRS, the financial statements have displayed improvement in their qualities, and it has automatically led to the upheaval of the financial reporting process. It is recommended through this paper that the top management, external auditors, and regulators should tighten the compliance of their accounting standard to IFRS so that the company can be positively affected by the regulations of IFRS.

The empirical study has analyzed the relationship between accounting standards and the quality of financial reporting. The study further undertook an examination of the relationship between regulations and the quality of financial reporting. Also, the study investigated the dual relationship of accounting standards and control with that of the quality of financial reporting. Through the research of many companies, it has been found that the management of most of the companies agrees to the importance of a standard regulation in correcting the errors of financial statements (Liu and Sun 2015). These companies believe that strong regulations help in reducing instances of fraudulent activities. This in-turn helps in increasing the reliability of the financial statements. However, some of the companies still have a negative viewpoint regarding IFRS. These companies believe that IFRS does not contain sufficient information, which is needed by the investors to examine the performance of a particular company.

Drawbacks of IFRS

Though the adoption of IFRS is mostly advantageous for the companies, still the framework comes with specific challenges in the business environment.

1) The increased cost of implementation for the growing businesses

Big businesses can quickly adapt to the IFRS framework for the improvement of their financial reporting process. However, the small businesses would suffer adversely while they try to accustom to the structure of IFRS (Black and Nakao 2017). The small and medium enterprises generally have limited resources, which are utilized in their operations. Therefore, they have to provide maximum time and effort to train the employees regarding the system of financial reporting and IFRS.

2) Concerns with standard manipulations

The IFRS standard is quite flexible, which might be disadvantageous in many scenarios. The companies can exploit this feature to incorporate only those methods of reporting, which would be beneficial to them (King’wara 2015). This will automatically display the results, which are desired by the companies. This makes it easier for companies to hide their financial issues and manipulate their financial statements accordingly.

3) The requirement of global consistency in auditing and enforcement functions

The differences in the political and economic systems of the countries decrease the worldwide uniformity of IFRS. This makes it difficult for the states to implement an effective enforcement policy along with standardized accounting rules (Pricope 2017). These political and economic differences would also reduce the comparability amount of financial statements, even after the application of IFRS.

4) Turmoil in the transition period

After the enforcement of IFRS, the organizations are required to shift from their current standard of financial reporting to the standard stipulated in IFRS. In this transition period, the companies might face risks of cost delay or any other threats, which might be detrimental for their business (Kouki 2018). Every country maintains its system of regulations, which regulate the financial reporting process instead of direct involvement with the standards. Therefore, the companies are required to consult multiple reports to gain adequate knowledge about the newly introduced standard.

There are many studies and researches, which explore the different strategies of adopting IFRS and explain them in light of the economic development of a country. One such study is undertaken by Othman and Kossentini. In this study, the underlying assumptions of economic theories are used for developing strategies of IFRS adoption (Al‐Htaybat 2018). The paper further analyses the potential effects of IFRS adoption on the development of the stock market. Fifty emerging economies are taken into consideration to conduct this empirical analysis through a dynamic panel model, under a span of 8 years. Through this study, the significant findings included a positive relationship between the stock market development and the high level of IFRS adoption (Mulyadi and Anwar 2015). However, in some of the companies, the adoption of IFRS has not proven successful for the economy. It has been observed that the local GAAP principles of these economies have shaped the basis of IFRS, and hence have created conflicts among the relationships between IFRS and GAAP.

From this paper, some other disadvantages of IFRS can be realized. One such limitation is the complex process of establishing this framework. Developing countries have found the process of adopting this framework very complicated, time-consuming as well as expensive. Despite its flexibility, IFRS also contains certain rigid elements, which hinders the process of implementation of new ideas into the system (Lin et al. 2019). Some aspects of IFRS are insufficient in providing a particular direction to the process of accounting. It has also been observed in some companies that all parties could not realize the importance of IFRS and, therefore, do not accept it into their system. The framework is useful only for a group of individuals who show interest and are recognized as users.

Earnings management

Earnings management is defined as the strategy, which is applied by the supervision of a particular company for manipulating the earnings and profit figures of the company. The command sets a pre-determined target for its key financials and fabricates the financial statements according to these forecasted targets (Wu and Zhang 2019). This practice helps in smoothing the income flow of the company. The earnings of the companies are fluctuating in nature, and they become either exceptionally good or bad in a short period. The companies try to stabilize their earnings through the process of earnings management. They either add or remove cash from the reserve accounts to balance the earning figure.

The Securities and Exchange Commission defines earnings management as a misrepresentation of earnings intentionally through materialistic approaches. To curb such malpractice, the SEC issue fines to those companies who display an excessive smoothness in their flow of income. The accounting laws of large companies are extremely involved. The companies exploit this complexity to practice earnings management. Due to a lack of knowledge of the investors, they could easily pick up accounting scandals to expose this unethical behavior of the companies. The companies conduct such a practice for producing a misleading picture in front of the investors and shareholders (Ho et al. 2015).  This would present a bright picture regarding the performance of the company in front of these people, so they carry out suitable investments in the company. Widespread research on earnings management has revealed that 8-12% of the firms having small pre-managed earnings, decrease manipulated profits for achieving the objective. 30-44% of firms manage losses to create positive earnings. A large number of companies practice earnings management for maintaining a steady growth in revenues and also for avoiding the red link in the reporting process.

Effect of IFRS on earnings management

Many studies have been conducted to find out the impact of IFRS on the process of earnings management. One such article written by Grecco, Gerron, and Lima, review such a relationship in the non-financial companies of Brazil. The study has tried to develop a model for analyzing the relationship between the two variables. Certain other variables are also included in the process, that is, corporate governance and regulatory environment surrounding the company. The most limiting factor in this process is the regulatory environment of the company (Dayanandan et al. 2016). Financial statements act as intermediary financial information between the investors and the managers. The process of elaboration of the financial report includes the management of a set of estimations and judgments regarding the operations. The administration also involves choosing the appropriate practices for adoption. A firm’s accounting value is judged by the way it decides to select and judge these practices.

A difficult situation is created when the management tries out new ideas for adopting these practices. The investors worry about the effectiveness of such choices, and therefore, a gap is created. Earnings management is limited by accounting regulations set up by IFRS. This is because IFRS lays down rules of capital markets, which ensure quality, comparability as well as transparency of information (Noh et al. 2017). The disclosure of the firms is also proposed through the regulations that determine the patrimonial position and performance of the companies. Due to the increased effectiveness of IFRS, it becomes less likely for the managers to manipulate the financial statements according to their pre-determined targets.

The accounting regulation, as laid down by IFRS, also plays a restrictive role in hindering the process of earnings management. The rules emphasise the roles and responsibilities of the auditors. The auditors must verify the financial and patrimonial position of the companies and clarify the reliability of the financial information presented to the external stakeholders of the companies. The auditors must display qualities of trust and credibility such that the accounting information is presented accurately to the external users (Abaoub and Nouri 2015). This process obstructs the practice of earnings management as the managers find less opportunity to manipulate their financial statements. Another feature of IFRS, which negatively affects the operation of earnings management, is corporate governance. Firms, which employ a better governance strategy abiding by the regulations of IFRS, are less likely to be involved in information asymmetry.

In recent years, the international accounting standards, including IFRS, have undergone significant changes to increase the acceptability and understand-ability of the financial statements to the end-users. This approach is expected to ensure a better quality of financial reporting through the reduction in the practice of earnings management. Due to various active elements of IFRS, the companies can now present a clear and accurate picture of their financial statements to the investors and shareholders (Ghazali et al. 2015). Through the process of IFRS adoption, the investors and shareholders are also benefitted, as they are no more misguided by the false financial statements of the companies.

Conclusion

From the above paper, it can be inferred that IFRS can be suitably adapted by the companies in the global environment to improve the financial reporting process. IFRS has laid down regulations for increasing the transparency, accountability, and comparability of the financial statements of the companies. Before the enforcement of IFRS, the companies were engaged in the practice of earnings management. Through earnings management, the company fabricated its financial records to present an inflated picture of its earnings in front of the shareholders. IFRS has led to a decrease in earnings management practices among companies.

References

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