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The Effects of International Financial Reporting Standards on Financial

Reporting Quality

Article · July 2019

DOI: 10.30958/ajbe.5-3-3

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 Athens Journal of Business & Economics - Volume 5, Issue 3 – Pages 221-242

The Effects of International Financial Reporting

Standards on Financial Reporting Quality

By Wafaa Salah & Abdallah Abdel-Salam†

The purpose of this study is to investigate whether the financial reporting under
International Financial Reporting Standards (IFRS) has more quality than local
GAAP for firms listed on Taiwan stock exchange. Financial Reporting Quality is
measured in this study by three attributes of earnings introduced in previous
literature, namely: 1) earnings management expressed as managing towards positive
earnings and earnings smoothing and, 2) timely loss recognition expressed as the
asymmetric incorporation of economic gains and losses and large negative net
income, and 3) value relevance. Ordinary Least Square (OLS) Regression analysis, Z-
test, and Binary Logistic Regression are employed to investigate the pre-IFRS (2008-
2010) and post-IFRS (2012-2014) adoption periods on value relevance, earnings
management, and timely loss recognition. The study employs a sample of 426
manufacturing firms from 8 industries listed on Taiwan stock exchange. The study
finds that firms adopting IFRS evidence less earnings smoothing. However, there is no
significant difference in either the timely loss recognition or the value relevance of
accounting information between the pre and post-adoption periods. This study
contributes to the literature by using data from an emerging market. It provides an
insight to practitioners, international standard setters and regulators into the
international debate on the effects of the switch from local GAAP to IFRS on
Financial Reporting Quality.

Keywords: Emerging market, earnings management, timely loss recognition, value

relevance.

Introduction

Investors around the world became suspicious about the quality of accounting
information due to corporate financial scandals resulting from fraudulent financial
reporting. They seek to have high quality, transparent and comparable financial
information to help in making rational investment decisions. The Financial
Reporting Quality (FRQ) is influenced by high-quality accounting standards and
its appropriate enforcement (Benyasrisawat 2011, Khanagha 2011). Therefore,
moving toward harmonized high-quality accounting standards is becoming an


Lecturer of Accounting, The British University in Egypt, Egypt.
†
Professor of Accounting, Cairo University, Egypt.

https://doi.org/10.30958/ajbe.5-3-3 doi=10.30958/ajbe.5-3-3
Vol. 5, No. 3 Salah & Abdel-Salam: The Effects of International Financial…

increasingly important issue to enhance the transparency and comparability of

financial information produced.
Since 2001, the International Accounting Standards Board (IASB) an
independent, non-profit organization has played an important role by developing high-
quality International Financial Reporting Standards (IFRS) for use internationally for
financial reporting purposes. Its main objective is to achieve international
convergence. The European Union’s publicly listed firms are required to prepare their
financial reports in accordance with IFRS. Taiwan adopted IFRS in 2012 and many
other developing and developed countries have either adopted IFRS or are in the
process of the adoption. Approximately 140 countries around the world have now
permitted IFRS adoption (Dayanandan et al. 2016).
IASB does not provide a clear definition of FRQ. However, Financial Accounting
Standards Board Statement of Financial Accounting Concepts No. 1 (1978) states that
“one objective of financial reporting is to help present and potential investors in
making rational investment decisions and in assessing the expected firm cash flows”.
Verdi (2006) defines FRQ as the accuracy with which financial reporting provides
information to investors about the firm’s activities, particularly its expected cash
flows. While Dechow et al. (2010) define as “Higher quality earnings provide more
information about the features of a firm’s financial performance that are relevant to a
specific decision made by a specific decision-maker”.
Researchers are investigating the effect of IFRS on FRQ. Some research shows
that adopting IFRS enhances FRQ in developed economies (Iatridis 2010, Jeanjean
and Stolowy 2008, Zéghal et al. 2011). However, the benefit to emerging markets still
unclear (Zhou et al. 2009). Other researchers show mixed results (Morais and Curto
2008, Paglietti 2010). On the other hand, some researchers show that adopting IFRS
may not satisfy the information needs of stakeholders and has negative effects on the
performance of the stock market and the trading volume (Ball 1995, Barth et al. 1999,
Bradshaw and Miller 2002, Yoon 2007). It has been argued that FRQ is highly
influenced by the opportunistic behavior of managers and national institutional factors
(Jeanjean and Stolowy 2008, Palacios et al. 2014). The principle-based orientation of
IFRS could add volatility to financial statements and open the door for possible
managerial manipulation (Ahmed et al. 2013).
The empirical evidence about the benefit of implementing IFRS is conflicting and
controversial. IFRS has been developed without regard for differences in socio-
economic and political environments between different countries. As a result, more
empirical evidence on whether the adoption of IFRS in emerging markets has
enhanced the FRQ regarding timely loss recognition, value relevance and the level of
earnings management is needed. It is important to focus on these three metrics in
emerging markets because IFRS is a principle-based approach which is characterized
by greater flexibility for manipulation of accounting information. This provides
managers the opportunity to manage earnings due to the encouragement of
professional judgment and discretion. According to Wong and Jian (2003), the

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Athens Journal of Business and Economics July 2019

emerging market experience more earnings management because of the relatively

weak investor protection and legal system.
The purpose of this study is to empirically investigate whether the adoption of
IFRS leads to higher FRQ for manufacturing firms listed on the Taiwan stock
exchange. The classification of Taiwan as an emerging market is based on the
classification of the World Bank in 2018. It exhibits the characteristics of an emerging
economy due to its weak corporate governance, poor legal enforcement and
inadequate shareholder protection (Huang and Shiu 2009). According to IFRS 1,
Taiwanese listed firms were required to issue their 2012 financial statements under
both IFRS and Taiwanese GAAP which provides a unique opportunity to investigate
this issue. According to Financial Supervisory Commission (2018), All firms listed on
Taiwan stock exchange and financial institutions supervised by the Financial
Supervisory Commission were required to apply IFRS starting from 2012 except
unlisted public firms, insurance intermediaries, credit card firms and credit
cooperatives. They were required to apply IFRS starting from 2015 (permitted from
2013).
Our empirical results show that firms in the post-IFRS period experienced lower
level of earnings smoothing compared to firms in the pre-IFRS period. However, there
is no evidence found that firms in the post-IFRS period evidenced more timely loss
recognition or more value relevance of accounting information than in the pre-IFRS
period. In particular, firms in the post-IFRS period have a higher variance of the
change in net income and a less negative correlation between accruals and cash flows.
This may suggest a significant reduction in earnings smoothing and improvement in
FRQ after the transition to IFRS. This study is complements the findings in the
existing literature regarding the effects of IFRS on FRQ.
This study contributes to the literature in several ways. First, the effects of IFRS
adoption on FRQ in emerging markets have not been widely studied (Kwon et al.
2017) and several emerging markets are in the process of adopting IFRS, such as
Saudi Arabian, Egypt, India, Korea, and Malaysia. This study encompasses a sample
of listed firms in Taiwan which is considered one of the emerging markets that have a
significant influence on the world economy (Bekaert and Harvey 2017). Thus
practitioners and international standard setters from other emerging markets can
benefit from the results of this study. Second, existing empirical studies have focused
on developed countries, such as Germany, Australia, the UK, and France (Peng and
Chen 2014, Kaaya 2015, Kwon et al. 2017). This study fills the gap of the related
literature by shedding the light on emerging markets. Third, the costs and benefits of
switching from local GAAP to IFRS are still unclear. This study provides empirical
evidence that compares the FRQ under IFRS with that under local GAAP and this can
benefit regulators as they try to make rational decisions regarding the adoption by
publicly listed firms in emerging markets. Finally, the findings of this study may help
analysts and investors understand IFRS and FRQ issues in emerging markets. This
study follows Barth et al. (2008) and Zhou et al. (2009) in focusing on three metrics of
FRQ: 1) value relevance, 2) earnings management, and 3) timely loss recognition.

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The remainder of this paper is organized as follows. Section 2 presents the related
literature and develops the hypotheses. Section 3 deals with the sample selection,
descriptive statistics of variables and the research methodology. Section 4 presents the
empirical findings and Section 5 concludes the study.

Literature Review and Hypothesis Development

The quality of financial reporting is determined by the usefulness of information

provided to meet the needs of users. One of the factors that affects FRQ is the
accounting standards. High accounting standards are characterized by providing
relevant, reliable, comparable and consistent accounting information (Khanagha
2011). Firms experience positive returns with increases in FRQ (Armstrong et al.
2010), a reduction in the cost of equity capital in countries with strong legal system
(Li 2010), and increases the demand for equities by institutional investors (Florou and
Pope 2012). Hence, literature tries to assess the effect of accounting standards on the
quality of financial information.
Prior research measures FRQ in different ways. The majority of studies use value
relevance, timely loss recognition, and earnings management as three main measures
for FRQ as they provide useful financial information to stakeholders especially users
in the equity market (Ahmed et al. 2013, Barth et al. 2008, Istrate et al. 2015, Jeanjean
and Stolowy 2008, Morais and Curto 2008, Mousa and Desoky 2014, Paglietti 2010).
Francis et al. (2004) consider seven measures of accounting quality, namely, earnings
management, persistence, predictability, smoothness, value relevance, timeliness, and
conservatism. On the other hand, Benyasrisawat (2011) points out three dimensions of
FRQ, namely, earnings persistence, value relevance and earnings timeliness. This
study uses three attributes of earnings introduced in previous literature (Barth et al.
2008, Kaaya 2015, Lin et al. 2012, Mousa and Desoky 2014, Peng and Chen 2014,
Zhou et al. 2009). The attributes are 1) value relevance, 2) timely loss recognition
expressed as the asymmetric incorporation of economic gains and losses and large
negative net income, and, 3) earnings management expressed as managing towards
positive earnings and earnings smoothing.
Paglietti (2010) defines earnings management as the management intention to
mislead stakeholders about the financial position of the firm which may affect their
compensation. He adds that higher quality of accounting information is characterized
by low earnings management. On the other hand, value relevance studies are
concerned about the evaluation of the relationship between accounting information
and capital market values (Khanagha 2011). It is argued that higher quality of
accounting information exhibits a strong relationship between earnings and returns
(Mousa and Desoky 2014). Outa (2011) defines timely loss recognition as “the firm’s
ability to recognize losses as they occur by not engaging in activities that reschedule
the losses over other periods of time”. Coelho et al. (2017) argue that more timely

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Athens Journal of Business and Economics July 2019

recognition of the incurred losses in earnings make financial reporting more

informative to investors and decision makers.
Several studies have tried to study the impact of adopting IFRS. Studies carried in
developed countries regarding the higher quality of IFRS information reveals
contradicting results. On the positive side, Irvine and Lucas (2006) find that IFRS has
increased foreign direct investment, improve FRQ and enhance global market
integration. Using a sample of 327 firms from 21 countries, Barth et al. (2008) find
that firms exhibit less earnings management, higher frequency of large losses, an
insignificant frequency of small positive earnings, and more value relevance of FRQ
after voluntarily switching to IFRS. Similarly, the findings of Iatridis (2010) suggest
that the implementation of IFRS in the UK decrease earnings management, lead to
more value relevant accounting measures and more timely loss recognition which help
investors in making more rational decisions. These two studies provide consistent
results and suggest that adopting IFRS reinforces information reporting quality.
Moreover, an empirical study by Armstrong et al. (2010) document that the adoption
of IFRS in the European stock market improved the information transparency and
earnings quality. Using a longitudinal study that covers pre-IFRS and post-IFRS
periods during 1990–2008 for publicly listed Australian industrial firms, Chalmers et
al. (2011) find that earnings become more value-relevant and suggest that IFRS
adoption affects the associations between accounting information and market value.
Several studies have confirmed that adopting IFRS has increased FRQ (Chalmers et
al. 2011, Devalle et al. 2010, Meeks and Swann 2009, Chan et al. 2015).
Other studies report contradicting results. A study by Van Tendeloo and
Vanstraelen (2005) suggest that there is no significant difference in FRQ for firms
adopting IFRS compared to firms adopting German GAAP. Similarly, using a sample
of German firms applying IFRS since 2005, Lin et al. (2012) suggest a decline in
FRQ under IFRS. They find that financial reports evidence less value relevance, less
timely loss recognition, and more earnings management compared to those firms
applying U.S. GAAP. These two studies provide consistent results and suggest that
adopting IFRS does not enhance information reporting quality. Both Ahmed et al.
(2013) and Christensen et al. (2015) find that European Union firms experience more
earnings management after IFRS adoption. Ahmed et al. (2013) argue that firms that
have voluntary application to IFRS experience less earnings management due to
having incentives to increase the transparency of their reporting and attract market
capital. On the other hand, firms that have mandatory application to IFRS, lack the
motivation to have a transparent financial report which leads to higher earnings
management after the adoption of IFRS. However, Capkun et al. (2016) conducted a
study in 30 countries and found that firms adopting early, late or mandatory IFRS
experience an increase in earnings management. They concluded that the principle-
based nature of IFRS allows for greater flexibility in selecting accounting methods
and greater discretion in earnings measurement which lead to an increase in earnings
management. The conflicting results between the two studies may be due to
differences in sample selection where Ahmed et al. (2013) sample include only

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developed countries (European Union) while Capkun et al. (2016) sample includes
both developed and developing countries which have a different legal system, capital
market maturity, and development.
The studies presented above are applied in developed countries where we could
expect an improvement in FRQ after IFRS adoption due to strong investor protection,
strong legal enforcement, and capital market maturity. However, the results are mixed
which makes it difficult to reach a general conclusion that IFRS enhance FRQ in
developed countries. This result is supported by Nulla (2014) who observed that each
country implemented the same accounting standards in a different way due to flexible
standards which can lead to a reduction in FRQ even in strong enforcement countries
like Germany and France.
Regarding the developing countries, Aljifri and Khasharmeh (2006) investigated
the benefits of IFRS to the United Arab Emirates (UAE). They found that there is a
general agreement among different users as investors, auditors and creditors on the
importance of applying IFRS in the UAE. Similarly, Liu et al. (2011) examined the
effect of IFRS on FRQ for publicly listed firms in China and find significant
improvement expressed as an increase in value relevance of accounting information
and a reduction in earnings smoothing. In a two emerging counties study, Khanagha
(2011) investigated the value relevance of accounting information under IFRS in
Bahrain for the period 1996-2008 and the United Arab Emirates for the period 2001-
2008 listed firms. A comparison of the results for the pre and post-IFRS adoption,
shows more relevant accounting information after the adoption of IFRS in Bahrain
stock market, while there was a decline in value relevance for United Arab Emirates
stock market. Using a sample of 117 listed firms in Indonesia Stock Exchange, Arum
(2013) examined the impact of IFRS on the FRQ which are measured by the proxy of
value relevance, timely loss recognition, and earnings management of accounting
information. The empirical results indicate lower earnings management and higher
value relevance of accounting information while having no effect on the timely loss
recognition. This may signal an improvement in the financial reporting quality.
On the other hand, other studies show that adopting IFRS in developing
countries does not necessarily lead to an improvement in FRQ. Chen and Yeh (2002),
employing a sample of Chinese firms, examined the effect of adopting IFRS on FRQ.
Their study revealed that IFRS does not improve accounting practices due to family
ownership, informal personal relationship and political influences which contribute to
the low reporting quality. Similarly, Rudra and Bhattacharjee (2012) find that publicly
listed Indian firms using IFRS experience more earnings management compared to
Indians firms using local GAAP which may be considered as a signal to the regulators
to think about the effectiveness of IFRS in emerging markets suffering from weak
investor protection and legal enforcement. Ames (2013), using data of 3950 listed
companies in South Africa between 2000 to 2011 examined the impact of adopting
IFRS on FRQ. He finds that FRQ is not improved among the firms adopting IFRS. A
study of Taiwanese firms by Peng and Chen (2014) showed that the quality of the
financial reports under local GAAP provides more value relevant than IFRS. Other

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empirical studies find mixed results (Clarkson et al. 2011, Houqe et al. 2012, Outa
2011, Paananen and Lin 2009).Despite, the argument that IFRSs may not fit
developing countries due to weak investor protection and legal enforcement (Kaaya,
2015). It is clear that some studies presented show that IFRS improves FRQ. This
result is supported by Karampinis and Hevas (2009) who concluded that mandating
IFRS may prove beneficial even in an unfavorable context.
Based on the above discussion, this study aims to compare the FRQ under local
GAAP with that under IFRS by examining the impacts of implementing IFRS in one
of the emerging markets. The study will fill the gap of the related literature by adding
more evidence regarding emerging markets. Based on the above discussion that show
conflicting evidence on the effect of IFRS on FRQ, the following hypotheses are
formulated:

H1: Firms using IFRS experience less earnings management compared to firms
using local GAAP.
H2: Firms using IFRS experience more timely recognition of losses compared to
firms using local GAAP.
H3: Firms using IFRS experience more value relevant accounting information
compared to firms using local GAAP.

Methodology

In this section, three FRQ that has been suggested in prior research as potentially
important will be considered: value relevance, timely loss recognition, and earnings
management. They are examined separately by comparing accounting information
prepared under Taiwanese GAAP from 2008 to 2010 with those prepared under IFRS
from 2012 to 2014. Quantifying FRQ is difficult, Hence, this study follows Lang et al.
(2006), Barth et al. (2008) and Zhou et al. (2009) in focusing on a range of FRQ
measures. According to Lang et al. (2006), accruals are sensitive to the industry in
which the firm operates. Accordingly, the effect of industry on the characteristics of
accounting data was considered in this study.

Earnings Management

This study analyzes two measures of earnings management. The first relates to
the examination of earnings smoothing and the second focuses on managing towards
positive earnings.

Earnings smoothing

To test for changes in earnings smoothing, three different measures are used in
this study.

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1-First, the variability of the changes in the annual net income deflated by end of
year total assets. Earnings should fluctuate over time if firms do not use accruals to
manage earnings. Accordingly, lower values of the variance of the change in net
income are considered a signal to higher earnings smoothing, and vice versa. The
change in net income can be affected by factors other than the financial reporting.
Hence, controls from prior research have been used as shown in the below
model(Barth et al., 2008, Lang et al., 2006):

ΔNI = β0+ β1 SIZE + β2 GROWTH + β3 EISSUE + β4 LEV + β5 DISSUE + β6

TURN + β7 CF + β8 AUD + β9 XLIST + β10 NUMEX + β11SECTOR1 +
β12SECTOR2 + β13SECTOR3 + β14SECTOR4 + β15SECTOR5 + β16SECTOR6
+ β17SECTOR7 + β18ΔNI (-1) + (1)

Where ΔNI is the annual change in net income, SIZE is the natural logarithm of the
end of year market value of equity, GROWTH is the annual change in sales, EISSUE
is the annual change in common stock, LEV is end of year total liabilities divided by
equity book value, DISSUE is annual change in total liabilities, TURN is sales divided
by end of year total assets, CF is annual net cash flow from operating activities
divided by end of year total assets, AUD is an indicator variable that equals one if the
firm’s auditor is PwC, KPMG, E&Y or D&T and zero otherwise, XLIST is an
indicator variable that equals one if the firm is listed outside the EU, NUMEX is the
number of Stock Exchanges on which a firm’s stock is listed. SECTOR1 is the
Commodity Chemicals industry, SECTOR2 Iron & Steel industry, SECTOR3 is the
Auto, Truck & Motorcycle Parts industry, SECTOR4 is the Textiles & Leather Goods
industry, SECTOR5 is the Food Processing industry, SECTOR6 is the Construction &
Engineering industry, SECTOR7 is the Electrical Components & Equipment industry
and Machinery & Equipment is the reference category. ΔNI (-1) is a lagged value of
observed endogenous response variables for solving serial autocorrelation issue. is
the error term.
The residuals of the regression of model 1 are denoted as ΔNI* and their standard
deviation σΔNi*. Lower standard deviation could be considered as evidence of using
accruals to smooth earnings.
2- Second, the variability of annual changes in net income relative to the
variability of annual changes in cash flows. The variability of annual changes in cash
flows is the variance of the residuals of the regression of annual change in cash flow.
Despite the controls used in model 1, the variability in net income may be due to
activities that are not correlated with discretionary accruals (Lin et al. 2012).
Examining the variability of annual changes in net income relative to the variability of
annual changes in cash flows control this concern as firms with more variability in
cash flows will have more variability in net income. Controls have been used to
mitigate the effect of other factors as shown in the below model:

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Athens Journal of Business and Economics July 2019

ΔCF = β0+ β1 SIZE + β2 GROWTH + β3 EISSUE + β4 LEV + β5 DISSUE + β6

TURN + β7 AUD + β8 XLIST + β9 NUMEX + β10SECTOR1 + β11SECTOR2 +
β12SECTOR3 + β13SECTOR4 + β14SECTOR5 + β15SECTOR6 +β16SECTOR7 +
β17ΔCF(-1) +    (2)

Where ΔCF is the annual change in net operating cash flow and the residuals of
the regression of model 2 are denoted as ΔCF*. The second metric is concerned about
the variability of ΔNi* / ΔCF* over the pre-IFRS (2008-2010) and post-IFRS (2012-
2014) periods. This variability is denoted as σΔNi*/ ΔCF*. If firms use accruals to
smooth earnings, the variability of net income will be less than that cash flow.
3- Finally, the correlation between total accruals (ACC) and operating cash flows
(CF) helps in detecting the smoothing effect of accruals. If managers use accruals to
smooth earnings, there will be a negative correlation between them as managers may
tend to increase accruals when suffering from shortage in cash flows(Ball and
Shivakumar 2005, Paglietti 2010, Myers et al. 2007). Again, to control for the effect
of other factors, the following regression models are used:

CF = β0 + β1 SIZE + β2 GROWTH + β3 EISSUE + β4 LEV + β5 DISSUE + β6

TURN + β7 AUD + β8 XLIST + β9 NUMEX + β10SECTOR1 + β11SECTOR2 +
β12SECTOR3 + β13SECTOR4 + β14SECTOR5 + β15SECTOR6 +β16SECTOR7 +
β17CF (-1) + (3)
ACC = β0+ β1 SIZE + β2 GROWTH + β3 EISSUE + β4 LEV + β5 DISSUE + β6
TURN + β7 AUD + β8 XLIST + β9 NUMEX + β10SECTOR1 + β11SECTOR2 +
β12SECTOR3 + β13SECTOR4 + β14SECTOR5 + β15SECTOR6 +β16SECTOR7 +
β17ACC (-1) + (4)

Where ACC is net income (NI) minus CF. The residuals of the regression in
model 3 are denoted as CF* and the residuals of the regression in model 4 are denoted
as ACC*. The third metric is concerned about the correlation between CF* and
ACC*. The higher negative correlation between them signals the use of accruals to
smooth variability in earnings and thus affect FRQ (Myers et al. 2007).

Managing Towards Positive Earnings

The second earnings management measure tests if firms manage earnings

towards small positive earnings (denoted as SPOS) rather than a negative earnings.
According to Kwon et al. (2017), managers tend to smooth earnings to avoid losses
which may results in more frequent positive earnings, if possible, compared to small
losses. Hence, a high frequency of small positive earnings signals the greater
management’s discretion to avoid losses and thus affect FRQ. This measure is
evaluated by estimating the coefficient of a dummy variable SPOS in the following
logistic regression model(Barth et al. 2008):

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POST(0,1) = β0 + β1 SPOS+ β2 SIZE + β3 GROWTH + β4 EISSUE + β5 LEV+ β6

DISSUE + β7 TURN + β8 CF + β9 AUD + β10 XLIST + β11 NUMEX + (5)

POST(0,1) is a dummy variable that equals one for firms adopting IFRS and zero
for firms adopting local GAAP. SPOS equals one if the net income deflated by total
assets is between 0 and 0.01 and zero otherwise (Barth et al. 2008). This measure is
concerned about the coefficient of SPOS in the regression equation. If the coefficient
is negative, this means that firms in the pre-IFRS period are more likely to smooth
earnings toward small positive net income compared to firms in the post-IFRS period
and vice versa.

Timely Loss Recognition

Timely loss recognition is the second FRQ measure which reflects accounting
conservatism. Ball et al. (2000) define timeliness as “the degree to which accounting
income incorporates economic income”. It can be assessed by two metrics. The first
one focuses on the likelihood of reporting a large negative net income (denoted as
LNEG). Higher FRQ is characterized by recognizing large losses as they occur rather
than being deferred to future periods (Zhou et al. 2009). If managers smooth earnings,
large losses should be relatively rare. Hence, high frequency of timely loss recognition
signals better FRQ. The following logistic regression is constructed to estimate the
likelihood of loss recognition timeliness (LNEG) following IFRS adoption (Lang et
al. 2006):

POST(0,1) = β0 + β1 LNEG+ β2 SIZE + β3 GROWTH + β4 EISSUE + β5 LEV+

β6 DISSUE + β7 TURN + β8 CF + β9 AUD + β10 XLIST + β11 NUMEX+ (6)

LNEG is a dummy variable that equals one if the net income scaled by total
assets is lower than -0.20 and zero otherwise (Barth et al. 2008). This measure is
concerned about the coefficient of LNEG in the regression equation. If the coefficient
is positive, this means that firms in the post-IFRS period are more likely to recognize
large losses in a timely manner compared to firms in the pre-IFRS period and vice
versa.
The second measure of timely loss recognition is concerned about the asymmetric
incorporation of economic gains and losses. Appropriate loss recognition compared to
profit recognition has been used in prior research to estimate FRQ (Ahmed et al.
2013). The stock returns are used as a proxy for good and bad news and measured by
R2 of the return-earnings regression model proposed by Basu (1997):

Def(E) = β0 + β1(Def(E)) Drֿ + β2(Def(E)) r + β3(Def(E)) (Drֿ · r) +  (Def(E)) (7)

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Where Def(E) is earnings per share in year t deflated by stock price per share
in year t-1. Drֿ is a dummy that takes value one in case of bad news( if r < 0) and
zero otherwise and r is annual stock returns from six months after the firm’s fiscal
year-end. The interaction between Drֿ with r (β3) shows the incremental effect of
bad news relative to good news on earnings. According to Lang et al. (2006), the
information in earnings will find its way into the share price, so the concern is
whether the news is captured in earnings in a timely manner. FRQ is associated
with share price, therefore a higher R2 indicates higher reporting quality. In
addition, this measure is concerned about the magnitude of the coefficient of the
interaction between Drֿ with r (β3) in the regression equation. The large coefficient
is a signal of more timely loss recognition.

Value Relevance

Following previous studies, this study measures value relevance using the
price-earnings model (Collins et al. 1999, Van der Meulen et al. 2007). Value
relevance considers that high-quality financial reporting should have a high degree
of association with the firm’s share price which provides more useful information
to investors. The model distinguishes between positive and negative earnings as
follows (Ohlson 1995):

Pit = β0 + β1 Xit + β2 DX + β3 Xit * DX + β4 BVi,t-1 (8)

Where Pit is the share price three months after fiscal year end t, Xit is earnings
per share, DX is a dummy variable equal to one if earnings are negative or zero
otherwise and BVi,t-1 is the book value per share at the beginning of period t, It
should be noted that the coefficient of earnings, β1, reflects the pricing effect of
current earnings. The measure of value relevance is based on the adjusted R2 of the
model which examines the explanatory power of accounting information over
years (Wu et al., 2017).

The Sample

Taiwanese publicly listed firms have been required to switch from the
Taiwanese GAAP to IFRS in 2012. A sample of 426 firms listed on Taiwan stock
exchange is randomly selected in this study. Table 1 presents the sample industry
breakdown. The sample comprises a range of industries in the manufacturing
sector. Data is obtained from Thomson Reuters DataStream database covering six
years, pre-IFRS (2008-2010) and post-IFRS (2012-2014). The same set of 426
firms adopted Taiwanese GAAP in the pre-IFRS (2008-2010) and IFRS in the
post-IFRS (2012-2014) period.

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Table 1. Industry Analysis

Cumulative
Industry Frequency Percent Valid Percent
Percent
Auto, Truck &
198 5.2 5.2 5.2
Motorcycle Parts
Commodity
387 10.1 10.1 15.3
Chemicals
Construction &
225 5.9 5.9 21.1
Engineering
Electrical
Components & 1521 39.7 39.7 60.8
Equipment
Food Processing 225 5.9 5.9 66.7
Industry and
Machinery & 549 14.3 14.3 81
Equipment
Iron & Steel
270 7 7 88
industry
Textiles &
459 12 12 100
Leather Goods
Total 3834 100 100

Empirical Results and Analysis

Descriptive Statistics

Table 2 presents descriptive statistics for the test and control variables used in the
research design. Both have been examined separately under both local GAAP and
IFRS for the same set of firms. Data is approximately symmetric as skewness ranges
from -0.46 to 0.5. The descriptive analysis of the test variables reveals that there is a
slight decrease in the mean of the change in annual net cash flow (CF_DELTA) and
accruals (ACC) under IFRS compared to Taiwanese GAAP. This may signal a
decrease of earnings management practices under IFRS. However, there are no
significant differences in the mean and dispersion of the other test variables under
both local GAAP and IFRS.
As for control variables, the descriptive statistics show that the adoption of IFRS
causes a significant reduction in the mean of the annual change in sales (GROWTH)
from 355834 to -495997. Moreover, a significant reduction in the mean of the annual
change in common stocks (EISSUE) and the annual change in total liabilities
(DISSUE) under IFRS. This may signal that firms in the pre-IFRS period are more
likely to issue stocks and debt than firms in the post-IFRS period.
Table 3 reveals that the time series test and control variables are stationary at the
0.01 level. Table 4 shows that according to Schwarz criterion, there is a long-term
equilibrium relationship among the time series variables where the p-value of both
Tau-statistic and Z-statistic are at the 0.01 level.

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Table 2. Descriptive Statistics

Pre-IFRS (2008-2010) Post-IFRS (2012-2014)
Mean Median Std. Dev. Skewness Kurtosis Mean Median Std. Dev. Skewness Kurtosis

Test Variables
NI_DELTA -0.003 -0.002 0.012 -0.04 2.23 -0.002 -0.002 0.011 -0.09 2.33
CF_DELTA 569943 440354 2731030 0.15 2.57 552444 485586 2782907 0.14 2.42
ACC -3516552 -2989165 2797312 -0.55 2.39 -3514471 -3123636 2672059 -0.46 2.43
DEF 0.048 0.050 0.024 -0.09 2.05 0.048 0.048 0.023 -0.02 2.12
R 0.037 0.031 0.152 0.14 1.89 0.045 0.038 0.132 0.20 2.26
P 0.590 0.580 0.166 0.33 2.18 0.575 0.546 0.166 0.50 2.27
BV 0.489 0.482 0.066 0.43 2.52 0.497 0.493 0.070 0.25 2.18
X 0.031 0.030 0.018 0.28 2.25 0.031 0.028 0.019 0.44 2.27
Control Variables
LNSIZE 18.042 17.998 1.196 0.12 2.58 18.216 18.087 1.131 0.22 2.63
GROWTH 355834 228340 5927955 0.14 2.12 -495997 -648252 5419240 0.22 2.51
EISSUE 1119962 1185916 1007546 -0.20 2.08 539270 585250 1169628 0.19 1.76
LEV 0.879 0.852 0.216 0.40 2.33 0.888 0.880 0.219 0.27 2.25
DISSUE 1620513 1316895 3300458 0.12 2.32 814413 366747 3287520 0.52 2.65
TURN 0.903 0.852 0.403 0.38 2.65 0.831 0.801 0.367 0.37 2.98
CF 0.061 0.061 0.027 -0.003 2.03 0.061 0.062 0.026 -0.01 2.11

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Table 3. Unit Root Test

Method Statistic Prob.** Cross-sections Obs
Null: Unit root (assumes common unit root process)
Levin, Lin & Chu t* -71.0288 0.0000 16 20413
Null: Unit root (assumes individual unit root process)
Im, Pesaran and
-63.7571 0.0000 16 20413
Shin W-stat
ADF - Fisher Chi-
2341.98 0.0000 16 20413
square
PP - Fisher Chi-
2606.64 0.0000 16 20432
square
**Probabilities for Fisher tests are computed using an asymptotic Chi-square distribution. All
other tests assume asymptotic normality.

Table 4. Tau and Z-statistics

Dependent tau-statistic Prob.* z-statistic Prob.*
NETINCOME -18.42707 0.0000 -536.7976 0.0000
NI_DELTA -16.62892 0.0000 -454.5156 0.0000
LNSIZE -12.56317 0.0000 -422.3788 0.0000
GROWTH -12.73522 0.0000 -326.5989 0.0000
EISSUE -17.43492 0.0000 -487.8751 0.0000
LEV -14.80203 0.0000 -530.8698 0.0000
DISSUE -18.41085 0.0000 -535.3919 0.0000
TURN -14.06258 0.0000 -574.5237 0.0000
CF -18.34584 0.0000 -532.5232 0.0000
CF_DELTA -19.47992 0.0000 -585.8725 0.0000
ACC -18.40662 0.0000 -535.9143 0.0000
DEF -17.04257 0.0000 -473.4941 0.0000
R -14.28235 0.0000 -352.1540 0.0000
P -22.03178 0.0000 -704.3500 0.0001
BV -20.40924 0.0000 -628.7475 0.0000
X -21.83900 0.0000 -695.1914 0.0001

Earnings Management

Table 5 presents the results for earnings management measures: managing

towards positive earnings and earnings smoothing for firms adopting local GAAP
from 2008 to 2010(pre-IFRS) and adopting IFRS from 2012 to 2014(post-IFRS).
The first result, the test of the variability of ΔNI* suggests that earnings are less
volatile for firms in the pre-IFRS period, 0.00834, than for firms in the post-IFRS
period, .00941, after controlling for other factors. This difference is statistically
significant at the 0.01 level which suggests a significant reduction in earnings
smoothing and improvement in FRQ after the transition to IFRS. On the contrary,
the second result, the ratio of the variance of change in net income, ΔNI* to the
variance of change in cash flow, ΔCF* is lower for firms in the post-IFRS period,
0000001902, than for firms in the pre-IFRS period, 0.0000004745. Although this
may suggest that the variability in net income for firms in the post-IFRS period is
not due to the variability in cash flow but driven by the effect of accruals, it is not
statistically significant.

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The third result indicates the correlation between cash flows and accruals. The
correlation between CF* and ACC*, for the pre-IFRS period, -0.54, is
significantly more negative than the post-IFRS period, -0.038. There is a
significant negative correlation between cash flow and accruals at the 0.05 level in
the pre-IFRS period. This may suggest that management may use accruals to
smooth earnings when cash flow is low. The negative correlation between accruals
and cash flow decreased when moving from local GAAP to IFRS. This may
indicate that firms adopting IFRS are less likely to use accruals to smooth
earnings. This result is consistent with the first one which supports the increase in
the quality of financial reports after the IFRS adoption. Finally, the regression
coefficient of SPOS is negative which may indicate that firms in the post-IFRS
period are less likely oriented towards reporting small positive earnings compared
to pre-IFRS. However, the coefficient is insignificant. This indicates that there is
no statistically significant difference between firms in the post and pre-IFRS
period in managing earnings toward a target.

Table 5. Comparison of the Pre-IFRS and Post-IFRS Earnings Management

Earnings Smoothing PRE-IFRS (N=1278) POST-IFRS (N=913)
Variability of ΔNI* 0.00834 .00941***
Variability of ΔNI* over
0.0000004745 .0000001902
ΔCF*
The correlation of CF* and
-0.54** -0.038
ACC*.
Managing Towards Positive
Earnings
Small Positive NI(SPOS) Beta = -0.61 Exp(B) = 0.941
The symbols **, *** indicate a significant difference between pre-IFRS and post-IFRS at the
0.05 and the 0.01 level respectively.

In summary, the above-mentioned results show that firms in the post-IFRS

period and less likely to use accruals to smooth earnings compared to the pre-IFRS
period. In addition, there are no statistically significant differences between firms
in the pre and post-IFRS in the ratio of the variance of change in net income,
ΔNI*, to the variance of change in cash flow, ΔCF*, and managing earnings
toward a target. This result supports the first hypothesis which states that “Firms
adopting IFRS are less likely to manage earnings compared to firms adopting local
GAAP”.

Timely Loss Recognition

Table 6 presents the results for timely loss recognition: asymmetric

incorporation of economic gains and losses and large negative net income. The
negative coefficient indicates that firms in the post-IFRS period are less likely to
report large losses. However, the coefficient of LNEG is insignificant. In another
word, there is no significant difference between pre and post-IFRS in reporting
large negative losses. Table 6 shows the R2 of the regression equation of
accounting earnings on stock returns for both good news and bad news. Earnings
are regressed on annual stock returns, an indicator that represents bad news and the

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interaction of these two predictors. The R2 in the pre-IFRS is 0.5933 which is

larger than that in the post-IFRS which is 0.4493. This indicates that earnings
under local GAAP proportionally shows greater timeliness in presenting losses
relative to gains. The magnitude of the coefficient of the interaction variable (Β3)
is significant under both local and IFRS GAAP although its magnitude is smaller
in the pre-IFRS, -1.719491, compared to the post-IFRS, -1.425209 which is
inconsistent with the R2 result. However, there is no significant difference between
the two coefficients. This indicates that there is no significant difference between
pre and post-IFRS in the timeliness of earnings which is consistent with the
previous result.

Table 6. Comparison of the Pre-IFRS and Post-IFRS Timely Loss Recognition

Timely Loss Recognition PRE-IFRS (N=1278) POST-IFRS (N=913)
Large Negative Net
Income(LNEG) Beta = -0.105 Exp(B) = 0.901
β1= 0.332621#
β1 = 0.354147#
Asymmetric Incorporation Β2= 1.617809#
Β2= 1.621350#
Of Economic Gains And Β3= -1.425209#
Β3= -1.719491#
Losses 2 R2= 0.449316
R = 0.593385
The symbols *, *** indicate a significant difference between pre-IFRS and post-IFRS at the
0.1 and 0.01 level respectively. The symbol # indicates significantly different from 0 at the
0.01 level.

In summary, the above-mentioned results show that there is no significant

increase in the timely loss recognition after the adoption of IFRS. This may
signal no change in the FRQ. This result does not support the second
hypothesis which states that “Firms adopting IFRS are more likely to recognize
losses in a timely manner compared to firms adopting local GAAP”.

Value relevance

Table 7 presents the degree of association between financial measures and

stock prices. The adjusted R2 for firms in the post-IFRS, 0.30866, is larger than
that of pre-IFRS, 0.232839. This indicates that the financial reporting data is
more value relevant in the post-IFRS compared to the pre-IFRS period which
increases FRQ under IFRS. Focusing on the regression coefficients, it is clear
that all variables increase their influence on the share price in the post-IFRS
period. In the pre-IFRS period, the regression coefficient of earnings per share
(β1) and the interaction variable (Β3) are significant at 0.01 level. In the post-
IFRS period, all regression coefficients increased in magnitude and are
significant. This indicates that all variables increase their influence on stock
prices in the post-IFRS period. However, the chow F-statistic shows no
significant difference between the regression coefficients in the post and pre-
IFRS period. This indicates that there is no significant difference in value
relevance after adopting IFRS which is consistent with the previous result. This
result does not support the third hypothesis which states that “Firms adopting

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IFRS are more likely to have value relevant accounting information compared
to firms adopting local GAAP”.

Table 7. Comparison of the pre-IFRS and post-IFRS Value relevance

Value Relevance Pre-IFRS (N=1278) Post-IFRS (N=913)
β1 = 0.815968# β1 = 1.336180#
The degree of association Β2 = 0.002505 Β2 = 0.041822##
between financial measures Β3 = -1.660291# Β3 = - 2.231037#
and stock prices. Β4 = 0.048866 Β4 = -0.119618###
Adjusted R2 = 0.232839 Adjusted R2 = 0.308661
The symbols #, ##, ### indicate significantly different from 0 at the 0.01, 0.05 and 0.1 level
respectively.

The above results support the argument that IFRS reduces earning
management. In addition, they do not support the argument that firms adopting
IFRS are more likely to recognize losses in a timely manner nor more likely to
have value relevant accounting information than firms adopting local GAAP. In
other words, the results suggest some improvement in FRQ under IFRS. This
study result is consistent with the findings of the study of Zhou et al. (2009) who
find that firms adopting IFRS are less likely to smooth earnings than firms
adopting Chinese GAAP. In addition, they didn’t find adopting firms engaging in
a more timely loss recognition which is consistent with Kwon et al. (2017), who
documents lower earnings management in Korea after IFRS adoption, and Wu et
al. (2017), who find that adopting IFRS in Taiwan does not lead to further
increases in value relevance of financial reporting. The results support the findings
of many other studies such as Eccher and Healy (2000), Van der Meulen et al.
(2007) and Lin et al. (2012).
At the same time, this study result is inconsistent with the findings of Ching-
Chieh et al. (2012), who finds that firms adopting IFRS in Taiwan are more value
relevant, Mousa and Desoky (2014) who find some improvement in the value
relevance after the adoption of IFRS and Capkun et al. (2016), who find an
increase in earning management after mandatory IFRS adoption. The results are
also inconsistent with the findings of many other studies such as Liu et al. (2011),
Khanagha (2011) and Adibah Wan Ismail et al. (2013). One possible reason for
the above results is that the stakeholders are affected not only by standards applied
but also by other factors. Another possible reason is the characteristics of the
emerging markets which might hinder the benefits from IFRS adoption as the
weak corporate governance, inadequate shareholder protection and the lack of
effective controls and infrastructure to oversight reporting under the IFRS. In
addition, convergence in a country that has high-quality accounting standards may
not significantly improve all the measures of the financial reporting quality.

Conclusions

The current study extends the literature on the effect of IFRS on financial
reporting quality and examines three attributes namely: value relevance, timely

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loss recognition, and earnings management. It sheds the light on the role of IFRS
in emerging markets to provide more evidence of the impact on the quality of
financial information. The results show that firms in the post-IFRS period (2012-
2014) are less likely to use accruals to smooth earnings compared to the pre-IFRS
period (2008-2010). However, there is no significant difference in the timely loss
recognition or the value relevance of accounting information under IFRS. The
results suggest some improvement in FRQ under IFRS. This indicates that
adopting high-quality accounting standards is not enough to guarantee
improvement in FRQ.
This study is subject to several limitations. First, the study sample is limited to
the industrial sector. It could be expanded by examining other sectors. Second,
only three measures of FRQ are investigated. Further studies can be conducted
using other measures as earnings persistence, loss avoidance, and investor
responsiveness. The results imply the importance of IFRS and thus have direct
implications for practitioners, international standard setters, and regulators. In
addition, the results are of interest to analysts and investors who need to
understand IFRS and FRQ issues in emerging markets.

Acknowledgments

Our thanks to “Professor Lela Pumphrey”, Professor of Accounting in The

British University in Egypt, for proofreading this research.

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