(75) Jenő Beke
Why does the international accounting standardization have to play an important role in
sustainable economics and competitive environment?
bekej@ktk.pte.hu
University of Pécs, Hungary, H-7622 Pécs, Rakóczi Street, No.80
Abstract: Nowadays, especially under the global financial crisis companies in Hungary intend to
remain competitive and realize sustainable economic development. This competitive environment
requires that our companies have to create a clear business strategy. Accounting has to be part of
this business strategy, because it helps for businesses to achieve their strategic objectives.
International accounting standards are new globalization methods for business information system
and they are exported from the west countries to harmonize financial system over the world and in
Hungary too.
Purpose of my research is to analyse of the international accounting standards adoption effects on
business environment in Hungary. The examination period is between 2004 and 2007, because the
employment date of international accounting standards compulsory from listed firms in Hungary
from 2005.
My samples consist of 254 firms including the 69 listed on the Budapest Stock Exchange. Financial
data sources come from Stock Exchange financial system and the national business database. In
order to identify my results of this research I have elaborated the following hypothesis:
H1: Larger businesses, those with higher leverage, with more substantial foreign sales are more
likely to adopt international standards.
H2: The international accounting standards adopted firms attempt to report small positive profit
rather than large losses.
H3: New accounting methods are higher quality and value relevance for business financial
information systems
The hypothesis is tested by binary regression models because it is very useful in analysing
categorical date where the dependent variable takes only two values: 1 and 0. Parameters in the
logistic regression model are estimated with maximum likelihood method.
The results of this practical business research show that international standards firms achieved
higher and statistically significant positive coefficients that the local accounting rules users. In the
examination of the first hypothesis the finding is that larger firms those with higher leverage, with
more market capitalization and substantial foreign sales are more likely to adopt new methods. To
the second hypothesis: under standard adopting firms display small positive profit less frequently
possibly indicating less earnings management. In the last hypothesis practice I found that
standards adopting firms provide higher quality and value relevant accounting information
system.
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INTRODUCTION
Standardization is the process of developing and agreeing upon technical standards. The standard
is a document that establishes uniform engineering or technical specifications, criteria, methods,
processes, or practices. Some standards are mandatory while others are voluntary. Voluntary
standards are available if one chooses to use them. Some are de facto standards meaning a norm or
requirement which has an informal but dominant status. Some standards are de jure meaning
formal legal requirements. Formal standards organizations such as the International Organization
for Standardization or the American National Standards Institute are independent of the
manufacturers of the goods for which they publish standards.
In social sciences, including economics, idea of standardization is close to the solution for a
coordination problem, a situation in which all parties can realize mutual gains, but only by making
mutually consistent decisions. Standardization implies the elimination of alternatives in
accounting for economic transactions and other events. Harmonization refers to reduction of
alternatives while retaining a high degree of flexibility in accounting practices. Harmonization
allows different countries to have different standards as long as the standards do not conflict. For
example, within the European Union harmonization program, if appropriate disclosures were
made, companies were permitted to use different measurement methods: for valuing assets,
German companies could use historical cost, while Dutch businesses can use replacement costs
without violating the harmonization requirements.
Since in case such multinational companies like Daimler Chrysler owning more than 900
subsidiaries, operating on 5 continents in more than 60 countries, the published financial results
according to international standards is 1.5 times of the one according to German accounting
standards. If earning after taxation (EAT) – deducted actual tax burdens - according to US GAAP
is taken as 100 percent, due to differences between national accounting standards, EAT would be
25% more in UK, 3% less in France, 23% less in Germany and 34% less in Japan (Barth et al.,2007).
With increasing globalization of the marketplace, international investors need access to financial
information based on harmonized accounting standards and procedures. Investors constantly face
economic choices that require a comparison of financial information. Without harmonization in the
underlying methodology of financial reports, real economic differences cannot be separated from
alternative accounting standards and procedures. Harmonization is used as a reconciliation of
different points of view, which is more practical than uniformity, which may impose one country’s
accounting point of view on all others. Organizations, private or public, need information to
coordinate its various investments in different sectors of the economy. With the growth of
international business transactions by private and public entities, the need to coordinate different
investment decisions has increased.
International Financial Reporting Standards (IFRS) are accounting principles, rules, methods
(‘standards’) issued by the International Accounting Standards Board (IASB), an independent
organisation based in London, U.K. They purport to be a set of standards that ideally would apply
equally to financial reporting by public companies worldwide. Between 1973 and 2000,
international standards were issued by IASB’s predecessor organisation, the International
Accounting Committee (IASC), a body established in 1973 by the professional accountancy bodies
in Australia, Canada, France, Germany, Japan, Mexico, Netherlands, United Kingdom and Ireland,
and the United States. During that period, the IASC’s principles were described as ‘International
Accounting Standards’ (IAS). Since April 2001, this rule-making function has been taken over by a
newly-reconstituted IASB. From this time on the IASB describes its rules under the new label
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‘IFRS’, though it continue to recognise (accept as legitimate) the prior rules (IAS) issued by the old
standard-setter (IASC).The IASB is better-funded, better-staffed and more independent than its
predecessor, the IASC. Nevertheless, there has been substantial continuity across time in its
viewpoint and in its accounting standards.
In today’s business environment, companies need to take every advantage they can to remain
competitive. Global competition, rapid innovation, entrepreneurial competitors, and increasingly
demanding customers have altered the nature of competition in the marketplace. This competitive
environment requires companies’ ability to create value for their customers and to differentiate
themselves from their competitors through the formulation of a clear business strategy. Business
strategy must be supported by appropriate organizational factors such as effective manufacturing
process, organizational design and accounting methods too.
The fundamental purpose of international accounting is to help an organization achieve its
strategic objectives. Meeting these objectives satisfies the needs of its customers and other
stakeholders. Typical stakeholders include shareholders, creditors, suppliers, employees, and
labour unions. Corporations need to implement adequate internal controls, guidelines and policies
to stay competitive and increase profit levels. Senior leaders rely on management accounting and
strategy tools to review corporate processes and make short-term and long-term decisions.
The application of international financial reporting standards will allow greater comparison of
international financial results. More sources and reports will be available to a greater audience of
analysts to follow trends in countries where previously due to different regulations and thus
different reports these were less meaningful. The unified financial reporting system will probably
lead to new types of analysis and data, furthermore with the possible integration of new indicators
from the practice of certain countries.
PREVIOUS RELATED LITERATURE REVIEW
International accounting literature provides evidence that accounting quality has economic
consequences, such as costs of capital (Leuz and Verrecchia, 2000), efficiency of capital allocation
(Bushman and Piotroski, 2006) and international capital mobility (Guenther and Young, 2002).
Prior researches (e.g. Meeks and Meeks, 2002) have raised substantial doubt regarding whether a
global accounting standard would result in comparable accounting around the world. But
differences in accounting practices across countries can result in similar economic transactions
being recorded differently. This lack comparability complicates cross-border financial analysis and
investment.
Epstein (2009) compared characteristics of accounting amounts for companies that adopted IFRS to
a matched sample of companies that did not, and found that the former evidenced less earnings
management, more timely loss recognition, and more value relevance of accounting amount than
did the latter. They found, that IFRS adopters had a higher frequency of large negative net income
and generally exhibited higher accounting quality in the post-adoption period than they did in the
pre-adoption period. The results suggested an improvement in accounting quality associated with
using IFRS.
Chatterjee (2006) assigned that first time mandatory adopters experience statistically significant
increases in market liquidity and value after IFRS reporting becomes mandatory. The effects were
found to range in magnitude from 3 % to 6 % for market liquidity and from 2 % to 4 % for
company by market capitalization to the value of its assets by their replacement value.
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Daske et al. (2007) found that the capital market benefits were present only in countries with strict
enforcement and in countries where the institutional environment provides strong incentives for
transparent filings. In the order IFRS adoption countries, market liquidity and value remained
largely unchanged in the year of the mandate. In addition, the effects of mandatory adoption were
stronger in countries that had larger differences between national GAAP and IFRS, or without a
pre-existing convergence strategy toward IFRS reporting.
METHODOLOGY AND RESULTS
My research is based on a qualitative comparative approach. In order to identify the results of my
scientific research about the evaluation of the accounting standards in Hungary I have elaborated
the following hypotheses:
H1: Larger businesses, those with higher leverage, with more substantial foreign sales are more
likely to adopt international standards.
H2: The international accounting standards adopted firms attempt to report small positive profit
rather than large losses.
H3: New accounting methods are higher quality and value relevance for business financial
information systems
The purpose of this study was the measuring the differences between the national rules and the
international methods, the valuing and analyzing their effects on the business decisions. This
survey contains information on how local, national accounting rules differ from IFRS on
incorporating recognition, measurement, and disclosure rules.
To analyze business adoption decision my sample consists of Budapest Exchange Trade (BET)
companies who compulsory adopted international financial reporting standards in Hungary, from
2005. In this research the pre-adoption examination period is in year of 2004 and the post-adoption
is in year of 2006. My final sample comprises 65 IFRS adopting and 260 local (Hungarian)
accounting rules user firms. The manufacturing enterprises have the largest representation in my
sample. The study excluded banks, insurances, pensions and brokerages since their accounting
measures are not always comparable with industrial sectors. My samples consist of shareholders
companies with Hungarian headquarters and employed more than yearly average 50 employees.
For the chosen of the national accounting rules user enterprises I introduced mathematic-statistic
methods. An alternative approach it to create a matched sample of local rules businesses based on
criteria such as year and industry. It is chosen to incorporate all local rules firms due to
methodological concerns about the matched-pairs research design. Financial data are from
published accounting statements in BET and Hungarian Business Information database. In my
sample the businesses are classified into those following IFRS and those following national
accounting rules.
The adoption decision models are expanded relying Nobes (2006) researches and test if the
demand from internal performance evaluations is a factor in businesses decisions to adopt
international accounting standards under the global financial crisis situations. It is estimated in the
following logistic regression model (1) after the prior literature (Wu and Zhang, 2009):
Prob [Adopt=1] = Logit (a0 + a1 Close_Held0 + a2 Labor_Prod 1 + a3 RET 1 + a4 ROA 1 +
+ a5 Size 1 + a6 Lev .1 + a7Growth 1 + a8Foreign_Sales 1 )
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(1)
Where:
Close Held: Percentage of closely held shares at the end of event year (event year of 2009 for the
management turnover and employee layoffs analyses)
Labour Prod: Labour productivity (sales per employee) minus the median labour productivity
RET: Annual raw stock return
ROA: Return on Assets, accounting earnings is defined as net income before extraordinary items.
Size: Natural logarithm of market capitalization
Lev: Leverage, defined as long-term debt divided by total assets
Growth: Sales growth, current year’s sales change divided by prior year’s sales
Foreign Sales: Foreign sales divided by total sales.
The dependent variable Adopt is equal to 1 for adopting firms and 0 otherwise. All the
independent variables are measured around event year 0. This model includes year and industry
dummy variables.
The author included lagged variables on businesses performance (RET 1 and ROA 1 ), firm size
(Size 1 ), leverage (Lev .1 ), growth (Growth 1 ) on the right-hand side of the regression model and I
expected the coefficients on firm size, leverage and growth to be positive. There is also included
that foreign sales as a percentage of enterprise total sales (Foreign_Sales 1 ). The author expected
these variables to have positive signs.
The regression results are reported in Table 1.
Analysis
Close_Heldo
Labor_Prod-1
RET-1
ROA-1
Size -1
Lev-1
Growth-1
Foreign_ Sales-1
Estimate
-0.00445
-0.00005
-0.1134
-0.5609
0.2659
1.3004
-0.2883
1.2085
Standard Error
0.0026**
0.0003 **
0.1447
0.7148
0.0461***
0.4882***
0.2021
0.2301***
Marginal Effects*
-0.64%
-1.08%
-0.30%
-0.31%
4.21%
1.12%
-0.50%
3.08%
Table 1. Logistic analysis of accounting standards adoption decisions
(Source: Author’s own construction)
**,*** Indicate that a coefficient is significantly different from zero at the 10 percent, 5 percent, 1
percent levels, respectively (one-sided tests for coefficients with predictions and two-sided tests for
those without a prediction)
*Marginal effects measure the changes in the predicted probability from a one standard deviation
increase from the mean for a continuous variable and form 0 to 1 for an indicator variable with the
other variables measured at the mean.
In Table 1 the coefficients estimates, standard errors, and the marginal effects are reported in
columns (1) to (3), respectively. The Close_Held0 has a negative coefficient, -0.00445, and
significant at the 0.05 level. The percentage of closely held shares can also vary with business’
incentives to access the capital market as more closely held business may have lower demand for
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external capital. This is the reason why the research controls for various factors related to business
financing needs in the regression model.
The coefficient on Labor_Prod-1 is -0.00005 negative as expected and significant as the 0.05 level.
The marginal effect indicates that a one standard deviation increase in labour productivity reduces
the likelihood of adoption by 1.08 percent. Regression has reasonable predictive power with a
Pseudo R2 of 32 percentages.
It was expected that the coefficients on the percentage of closely held shares (Close_Held 0) and
labour productivity (industry-adjusted sales per employee, (Labor_Prod 1 ) variables to be
negative, because prior researches suggested that these variables associated with disclosure
incentives have predictive power for the adoption decision (e.g. Ball and Shivakumar, 2005,
Whittington, 2008). The control variables signed that larger businesses, those with higher leverage,
with more substantial foreign sales are more likely to adopt international standards. It was found
that Close Held is consistent with compensation contracting demands affecting business decisions
to adopt international accounting standards.
The marginal effect suggest that a one standard deviation increase in the percentage of closely held
shares decreases the adoption likelihood by 0,64 percent, or 5 percent of unconditional adoption
probability of 20 percent (65/325). This supports a greater demand for more informative and
conservative accounting earnings due to economic performance evaluations at more widely held
by businesses stimulating to adopt international accounting standards.
This practical research showed that both businesses earnings and stock returns effect on the
management performances. The businesses with lower labour productivity compared to their
industry peers have greater incentives to adopt international accounting system. However, the
results on turnover are sensitive to this change in variable specification. So the increase in the
sensitivity of turnover to accounting performance post-adoption is primarily driven by heightened
turnover sensitivity to accounting losses.
Accounting standards and P&L effects
This research examined whether enterprises determine small positive profits than large losses.
Previous studies [e.g. Burgstahler and Dichev (1997), Leuz et al. (2003)] suggested that large losses
tend not to be frequent. Our analysis employed the next model (2):
RRi,t = a0 + a1Profitabilityi,t + a2Dividendi,t + a3Growthi,t+ a4 Sizei,t+
+ a5Likvidityi,t + a6Leveragei,t + a7SPi,t + a8LLi,t + ei,t
(2)
Where:
SPi,t = dummy variable indicating a measure of small positive profits.
SPi,t = 1 if net profit scaled by total assets is between 0 and 0.01,
SPi,t = 0 otherwise.
LLi, = dummy variable indicating a measure of timely loss recognition.
LLi,t = 1 if net profit scaled by total assets is less than - 0.20,
LLi,t = 0 otherwise.
The results of model (2) are reported in table 2.
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Denomination
IFRS adopted
enterprises
National GAAP
followed enterprises
SP
-1,194**
0,451
LL
2,581*
1,324
Table 2: Small Profit or large Losses
(Sourse: Author’s own constructions)
* at 10% level significante
**at 5% level significante.
The data of the table prove that the companies which already adapted the IFRS were less willing to
hide the realized profit in the P&L when it was low, doing so, the probability of reporting the
small amount of profit (SP) was significantly negative (-1,194) in their case.
Furthermore, it can be stated that they did not tend to hide their large loss either. The latter
statement is a consequence of the positive and high value of the coefficient of LL (2,581). It is rather
specific for national accounting standard user companies to be in favour of reporting smaller
amount of profit (0,451) and avoid large losses to be reported in P&L, which is possible because of
following the accrual-based accounting.
Accounting standards and value relevance
The first value relevance test is an OLS regression of share price on book value per share and net
profit per share. Its model was followed by Hung and Subramanyam (2007) researches (3).
Pi,t = a0 + a1 BVPSi,t + a2 NPPSi,t + ei,t
(3)
Where:
Pi,t
= Total market value of equity deflated by number of shares outstanding,
BVPSi,t = Total book value of equity deflated by number of shares outstanding,
NPPSi,t = Total net profit deflated by number of shares outstanding.
The second value relevance test is an OLS regression of profits on stock returns. Its model was
employed by Lang et al. (2005) researches (4).
NPPi,t = a0 + a1 ARi,t + ei,t
(4)
Where:
NPPi,t = Net profit divided by beginning of year share price,
ARi,t = Annual stock return at year-end.
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The third value relevance test measured the association between IFRS-based book value and net
profit figures, then stock returns. Its OLS regression model was used by Gassen and Sellhorn
(2006) researches (5).
ARi,t = a0 + a1BVPSi,t + a2BVCHAi,t + a3NPPSi,t + a4NPCHAi,t + ei,t
(5)
Where::
BVCHAi,t = Variable indicating the change in firm book value following the transition
to IFRS,
NPCHAi,t = Variable indicating the change in firm net profits following the transition
to IFRS.
The results of value relevance models are summarized in table 3.
Denomination
Coefficients
IFRS adopted enterprises
NPPS
National GAAP followed
enterprises
2,041**
BVPS
0,547**
1,354**
AR
2841,145**
3694,124*
BVCHA
0,1941**
0,2941*
NPCHA
0,0182**
1,3541
R²
0,689
0,799
3,025**
*Statistical significance at 10% level,
**Statistical significance at 1% level.
Table 3: Accounting methods and value relevance
(Source: Author’s own construction)
My H3 assumption, namely that the information system of companies which adapted the IFRS
shows a higher value relevance than other national accounting standard user companies, is proven
by the data of table.
The first test of value relevance gave a result for earnings after tax/share (EPS) coefficient (3,025)
and for book value of equity/share (1,354) which is significantly (at 1 %) positive and higher at
IFRS applier companies than at others. These companies had also more prosperous, higher
correlation coefficient of financial indexes (R2 = 0,799).
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The second test of value relevance gave similar results because the coefficient of return on equity is
also significantly (at 10 %) positive and higher (3694,124) at companies which already have
adapted the IFRS.
The coefficient of book value change (1,3541) resulted significantly more positive at the IFRS user
companies according to the third test of value relevance. These results obviously prove that the
companies which adapted IFRS have an orientation towards a reporting policy based on stronger
reliability and more realistic/proper evaluation. However, the index presenting the change of Net
Profit (NPCHA) was also positive but not significantly at these companies (1,3541).
CONCLUSIONS
Standardization of financial accounting has tended to follow the integration of the markets served
by the accounts. The present impetus for global accounting standards follows the accelerating
integration of the word economy. The global accounting standards would enable the world’s stock
markets to become more closely integrated. The more closely world’s stock markets approach a
single market, therefore, the lower should be the transaction costs for investors and the cost of
capital for firms in that market. The differences in international reporting practice prior to IFRS
constituted a palpable barrier to efficient international investment, monitoring and contracting.
And the literature suggest that being confined to small segmented capital markets imposes a
substantially larger cost of capital on firms and transaction costs on investors, which would inhibit
much worthwhile investment. Although we do not have all elements for the cost-benefit
calculation, the evidence points to substantial net gains for smaller economies which have joined to
the IFRS regime. There is certainly empirical research evidence to support the notion that uniform
financial reporting standards will increase market liquidity, decrease transaction costs for
investors, lower cost of capital, and facilitate international capital formation and flow. And there is
a sufficient basis to endorse IFRS and begin the challenging task of educating users, auditors, and
regulators. Educators and practicing accountants alike have significant roles to play in this exciting
future.
My study scrutinized the consequences of the IFRS adoption. The practical results showed an
unpleasant picture regarding solvency and profitability at the examined companies.
My analyses have proven that the internal efficiency measured by accounting indicators of the
concerned companies depended on their financial situation, their capitalization also after IFRS
adaptation. As stated before, the IFRS adaptation had an influence on decreasing income of
leaders/managers too.
In my previous assumptions I have already supposed that the adoption of the IFRS can cause a
change in the internal evaluation methods of the accounting indicators regarding the concerned
companies. In fact, these changes are correlating with the impact on management fluctuation and
cut-back of reported profitability.
Companies with more substantial foreign sales are better likely to adopt international accounting
standards.
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According to the previously quoted studies and researches, the reported accounting results after
IFRS adaptation are no more flexibly changeable and as a consequence of cost-benefit accounting,
they are transparent too. Being so, the IFRS are becoming one of the most efficient tools for internal
performance measurement and evaluation.
I have examined the practical realization of the assumptions supposed, through accounting data of
national companies (in the sample) and I found that – except for some case – the results were in
correlation with my hypothesis.
Finally, the value relevance of internal accounting information system was much higher in the
years after the IFRS adaptation than before.
The author can advise for international business researchers to employ these methods and
measure their effects on practical management functions.
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