THE EFFECT OF CONVERGENCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARD [IFRS]-BASED ACCOUNTING STANDARDS ON STOCK MARKET By ssoekarno THE EFFECT OF CONVERGENCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARD [IFRS]-BASED ACCOUNTING STANDARDS ON STOCK MARKET: EVIDENCE FROM MALAYSIA PUBLIC LISTED COMPANIES EVI OKTAVIANI SORAYA A project report submitted in partial fulfillment of the requirements for the award of the degree of Master of Business Administration International Business School UniversitiTeknologi Malaysia JANUARY 2014 I declare that this thesis entitled “The Effect of Convergence with International
Financial Reporting Standard [IFRS]-Based Accounting Standards On Stock Market: Evidence From Malaysia Public Listed Companies” is the result of my own research except as cited in the references. The thesis has not been accepted for any degree and is not concurrently submitted in candidature of any other degree. Signature: Name Date :JANUARY 2014 Dedicated to ACKNOWLEDGEMENT BSTRAK laDle 0T content CHAPTER 1 INTRODUCTION 1 Background 0T study 1. 1 Background of International Financial Reporting Standard [IFRS] Financial statements are important for investor in assisting them in making decision on where to invest globally.
This is why high-quality accounting standards enables investors to receive appropriate information which in turn will give investor confidence in making decision . There is a drive to globalize accounting standards and practices that will be accepted by the regulators, certification bodies, the accounting profession and the business and academic communities around the world in order to minimize the potential dangers of bias, misinterpretation, inexactness, and ambiguity. Over the years the business community has recognized accounting as the language of business and financial information as a form of language.
Since accounting has been accepted as a language, it is advisable that companies around the world to speak in the same language. Recent political and economic events have focused on the pressing need for more uniformity in international accounting standards . There is a requirement for a universal set of accounting standards which can unite the language of accounting around the world and solve the problem of differences in accounting practice. It is no surprise that the globalisation of capital markets has been accompanied by calls for globalisation of financial reporting.
Indeed, the globalisation of the world’s capital markets has created the need for comparable and reliable financial information to support the varied transactions and operations of the markets Hora et al.. The accounting profession has faced the pressure of globalisation and continues to look for ways to produce financial situation using a unique accounting procedures that can be understood by all business society in the last few decades . Not only that, to ensure usability, financial information also supposed to be understandable and comparable to make credit decisions and investment more easily retrieved.
Though the process of internationalisation might be difficult, Anderson said that “a set of international accounting standards will allow new horizons of financial statement evolution by the fact that the comparative analysis of the rate of return and profit/loss set written in balance sheet has made the competition between companies become more pertinent”. In order to solve this problem, a novel global accounting standard International Financial Reporting Standard (IFRS) has been introduced. Currently IFRS has been increasingly adopted by accounting policy makers all over the world.
It is estimated ver one hundred countries are using International Financial Reporting Standards. For example, Australia and all members states of the European Union which have adopted IFRS since 2005, whereas Canada, India and Korea has moved into IFRS convergence in 2011 . I ne aaoptlon 0T Internatlonal Accounting stanaaras/lnternatlonal Hnanclal Reporting Standards (IAS/IFRS) by a significant number of developing countries in the past years is considered as one of the biggest events witnessed in the international accounting field.
For most of these countries, the application of IAS / IFRS accounting is the transition to a new paradigm. This paradigm, mainly based on the communication of good quality and useful financial information for decision-making , consider the investor involved in the stock market as a specific user of financial statements . The objective of this financial report primarily to offer investors the necessary information for them in order to properly evaluate the economic situation of the company which in turn allowed them to put their money in profitable investment opportunities.
Countries which have already adopted the IFRS accounting standard foresee various benefits, for example Australian government hopes that the setting of IFRS ccounting standards in Australia can lead to production of higher quality accounting standards which in turn will facilitate Australian business in terms of lower costs of capital and enables Australian companies to compete on an equal footing overseas, while also maintaining investor confidence.
In the meantime the Chairman of the Korea Accounting Standards Board and President of the Korea Accounting Institute stated that his organisation is optimistic about the benefits of IFRS adoption in that it will not only make Korean companies more competitive through their enhanced ransparency but also will allow the South Korean accounting industry to expand worldwide. From those two statements, we can conclude that one common benefit sought by adopting IFRS is to eliminate barriers to cross-border investing .
Moreover, Ball argued that IFRS promises more accurate, comprehensive and timely financial statement information compared to the national standards which it replaces for the public financial reporting in most of the countries which adopted it, including Continental Europe. Better quality financial statement information can even lead to etter assessment by investors in making capital market decisions and thus reduce the risk to these investors.
Another attribute of IFRS is that it requires more extensive disclosure. For example, asset impairment FRSI 36 requires disclosure of goodwill and other intangibles, particularly in relation to the allocation of goodwill to cash generating units, the main assumptions used to measure recoverable amount and impairment testing. Increased level of disclosure in the financial statements may affect the quality of reported earnings.
According to disclosure system which set at high quality standard ives investor confidence in the credibility of financial reporting. If more disclosure is required, any attempt to manage earnings can be more easily detected and addressed by the internal oversight bodies (board of directors and auditors) in a company. The use of international accounting standards in promoting various players in the capltal market can De a good cnolce Tor developing countrles tnat seek to promote decent functioning of their capital markets.
To satisfactorily fulfill their role in the evaluation and financing of companies and in the development of various sectors of conomic activity, listed companies have to communicate good financial information . Since worldwide adoption of IFRS would create a common language for accounting, new capital markets would open to companies who have been reporting only in accordance with their national standards. Communication of financial information helps to limit the problems associated with information asymmetry and establishes a climate of confidence in the capital market mechanism.
This in turn acts to encourage different actors to make more transactions. IFRS would allow the financial statements to be in a simple, nderstandable, and standardized format for investors and other businesses who are interested in the firm. A research which conducted by Centre for Audit Quality on July in the United States shows that sixty-two per cent of investors agree that the creation of a single, uniform, international set of accounting standards would give them a higher level of confidence .
In general, convergence to IFRS provides many benefits such as enhancing comparability as a company financial report can easily compared to another, increasing global investment flow through transparency, decreasing cost of capital hrough global investment opportunity, rising financial reporting efficiency and enhancing financial reporting quality by lowering the chance to do earning management practice. However, despite the optimistic expectations put on IFRS convergence, the reality seems more unclear.
Previous research which have studied the relationship between IFRS adoption and market behavior has seen a variety of results, for instant Horton and Serafeim which investigate market reaction to IFRS and valuation of IFRS reconciliation adjustment, their study resulting a negative abnormal return for firms eporting negative earnings reconciliation, mandatory IFRS adoption alters investors’ beliefs about stock prices, proving that the new IFRS numbers give new information to the market. Meanwhile Armstrong et al. finds that equity investors perceived the expected benefits of more comparable financial reports and the prospects of increased capital flows outweighed the expected costs of implementation and any economic distortions arising from reduced local accounting diversity. Furthermore study result shows that annual report publication does not produce unexpected nformation either before, on, or after the adoption of IFRS, however she found an interesting fact that IFRS adopters are valued higher before the adoption, but not afterwards. . 2 International Financial Reporting Standard in Malaysia Malaysia cannot let itself to be left behind in this worldwide movement towards aaoptlon 0T tne S Malaysian companles nave to De In step wit n tnese developments in financial reporting practices adopted around the world in order to make their financial statements accepted globally. Malaysian Accounting Standards Board chairman foresee to that by becoming fully IFRS compliant, Malaysia’s capital nd financial market will be further enhanced.
In a statement, Azmi explained another benefit of adopting IFRS in Malaysia which are not only it is accepted globally as it already used in more than 100 countries, but using a common language also will turn reporting costs decrement since there is no need to reconcile accounts, can increase credibility of local market to foreign investors, have comparability across boundaries and cross border listing. Full convergence to international accounting standards will put Malaysia in good stead for increased globalization of capital markets, providing comparable financial tatements to promote investor confidence.
The milestone of IFRS convergence in Malaysia began in the period between 1978 and 1997 where Malaysia started to adopt International Accounting Standards (‘AS). However, those standards which were set by the Malaysian Association of Certified Public Accountant (MACPA) together with the Malaysian Institute of Accountants (MIA) were not enforceable on companies at that time. Following the passage of the Financial Reporting Act 1997 by Malaysia’s parliament on March 1997 prior to Asian financial crisis, the Malaysian Accounting Standard
Board (MASB) was established with a given mandated to developed financial reporting standards, develop Islamic accounting standard and conduct an extensive consultative process. Before 2005 all accounting standards issued by MASB had the prefix ‘MASS’. Subsequently in 2005, concurrent with global standard setting development, the MASB renamed all issued standards as Financial Reporting Standards (FRS) that was meant to be in line with standards issued by IASB except for some minor modifications.
In 2006, Malaysia introduced 2-tier financial reporting framework, started on 2007 Malaysian FRS standards (known as FRS framework) have been dentical to IFRS ‘AS. The difference lies in the standards that Malaysia has not adopted. The FRS framework is made mandatory for non-private entities while the private entities can continue using the old MASB standards known as PERS (private entity reporting standards) framework. Further, a new numbering system to its FRS and the interpretations was introduced by the MASB in 2007. MASB together with Financial Reporting Foundation (FRF), make up the new framework for financial reporting in Malaysia.
On 1 August 2008, they announced their plan to move to full IFRS convergence by 1 January 2012. To facilitate a phased changeover to IFRS convergence, Malaysia has adopted FRS 139 Financial Instruments: Recognition and Measurement with the effective date of 1 January 2010. By 2012, all approved accounting standards applicable to entities other than private entities will converge fully with all IFRS issued by the International Accounting stanaara In November 2011 , the MASB issued a new MASB approved accounting framework, namely the Malaysian Financial Reporting Standards (MFRS Framework).
As defined by MASB, the companies that are required to apply MFRS framework are “Entities Other Than Private Entities shall apply the MFRS framework for annual periods beginning on or after 1 January 2012, with the exception of entities (known as transitioning entities) which are given options to continue with the old FRS framework that has not adopted IAS 41 Agriculture and/or IC Interpretation 15 Agreements for the Construction of Real Estate. Next, MASB plans that the full adoption of the MFRS Framework will be mandatory to all companies for annual periods beginning on or after 1 January 2012. Because of this, approximately one thousand Malaysian public listed companies will be affected y the IFRS convergence in 2012, however the companies or the group of companies that are involved in agriculture or real estate industry still have time to defer its convergence. In addition, the International Accounting Standard Boards (IASB) future work plans on some other core standards will also affect Malaysian entities significantly after 2012.
There are a few IASB exposure drafts and discussion papers that are now going through due process and soon to be adopted including leases, revenue recognition, financial instruments, fair value measurement, insurance contracts, and consolidated inancial statements. As a consequence of this convergence, when IASB issues a new or amended IFRS, Malaysia will adopt those standards in their entirety. 1. 3 Problem Statement Principles-based standard accounting may reduce the likelihood of scandals, as shown on study by Nisbettt and Sheikh .
One example of a world phenomenon that has occurred related to financial statements matter is Enron scandal. Enron which was founded in 1985 is one of the world’s leading electricity, natural gas, communications and pulp and paper companies before it bankrupted in late 2001, its nnual revenues rose from about $9 billion in 1995 to over $100 billion in 2000. At the end of 2001 it was revealed that its reported financial condition was sustained substantially by institutionalized, systematic, and creatively planned accounting fraud. This scandal shows weakness of GAAP system as compared to principles- based standard such as ‘FRS.
The benefit of IFRS upon businesses that have adopted it is still debated. Previous studies have shown that the financial reporting process is influenced Jointly by the accounting standards and economic incentives of market participants . That said it follows that if companies can be shown the positive effect of adopting IFRS, they will be more willing to do so. I nls would Imply tnat companles mlgnt accept tne convergence witn IHRS positively IT, for example, they expect IFRS to impact favorably on company performance, and reduce information asymmetry and the cost of capital Hope et al..
In contrast, companies might expect the costs to surpass the benefits of IFRS adoption, or that IFRS implementation is followed by managerial opportunism to reduce the regulatory compliance costs or variation in the application of IFRS . Studies on the impact of adopting IFRS on market behaviour is still relatively new and unexplored, particularly in Malaysia. Most researches have only investigates its effect into financial statement and ratio such as Stent et al. or into accounting quality .
Many have focused solely on the technical accounting impacts related to IFRS. Understanding the broader impacts that IFRS may have is also important. Knowing such effects of IAS/IFRS convergence on stock market behavior is of major importance for several different parties including primarily, the national accounting standardization body, the IASB, nternational investors, as well as for the companies themselves. Although previous studies have provided evidence on the benefits of IFRS to quality of financial statement, such as Paglietti and Wang et al. there is a possibility that IFRS might not have a positive impact on company performance at all, in which case companies would not be too enthusiastic in adopting IFRS (outside of for compliance reasons). Based on the above discussion, this study will investigate whether adoption of IFRS is acknowledged by investment community and influences the investment decision making. The research result expected will give insight to firm and Jurisdiction whether to move into a single standard on financial reporting or not.
This can be useful information for other emerging markets that are still not fully adopting this new standard such as Indonesia and Thailand. 1. 4 Research Question Signalling theory explains that signalling is done by management in order to reduce information asymmetry. A signal is an action taken by the more informed that provides credible information to the less informed. The theory assumes that managers of high-quality firms will have an intention to signal their superiority to the arket as described by Copeland et al..
One such example of signalling is accounting conservatism in which firms provide financial statements information to show that they applying conservative accounting policies which resulting a higher quality of earnings because its principle is to prevents companies to exaggerate profits and helps financial statements reader by providing under representing income and assets. This accounting conservatism is traditionally defined by the adage “anticipate no profit, but anticipate all losses” . Understatement of profits and net assets stated in financial statements is a positive