IFRS: The Revolution That Never Was (at least not yet!)

Thomas Jeanjean, Professor of Acounting and Management Control - June 15th, 2009
Global finance reporting - IFRS

Key Ideas:

• The adoption of International Financial Reporting Standards (IFRS) has not improved the quality of corporate financial information.

• Reporting standards are not enough to ensure good financial governance in business organizations

Thomas Jeanjean ©HEC Paris

Thomas Jeanjean holds a PhD in accounting from the University of Paris Dauphine. He worked at the HEC Paris department of accounting and management control from 2003 to 2010. His (...)

In 2005, all of Europe’s listed companies gradually adopted the same financial reporting system for their consolidated accounts—the International Financial Reporting Standards (IFRS). This major change is a consequence of trade globalization,which has made standardizing financial account presentation a necessity.Theoretically, all companies have now adopted the same reporting “language,”but the question is, do they now actually speak the same language? International accounting expert Thomas Jeanjean has carried out two studies on the changes engendered by the application of the IFRS in a large sample of French and foreign companies. The studies show that the IFRS promise of higher quality financial information has yet to be kept. While the IFRS have made financial statements worldwide far easier to read, they do not account for differences in countries’ uses of reporting. In the UK, for instance, the primary purpose of financial reporting is to inform financial market investors. In contrast, in Germany,it is geared toward reassuring banks about organizational solvability. All countries thus do not have the same financial reporting “traditions” orobjectives, and these divergences explain why the great IFRS revolution has not occurred! 


IFRS HISTORY

The European Union functions according to the principle of free circulation ofpeople, goods, and capital. To be fully effective, this freedom requires any EUcompany’s financial accounts be understandable to all. The EU had beengrappling with this issue for nearly two decades, when overseas scandals in theearly years of the millennium (Enron, WorldCom, etc.) accelerated the financialinformation standardization process. In 2002, the persistent difficulty of findingcommon ground for reporting standards drove member countries to adopt normsdefined by the International Accounting Standards Board*, the privateorganization that created the IFRS in the 1970s. The IFRS had already beenauthorized in certain European countries, and it was decided to generalizetheir application throughout the EU as of 2005.


BUSINESS IMPLICATIONS OF THE IFRS

Prior to the 2005 adoption of the IFRS, financial reporting standards varied considerably from one country to another, and they were often quite different from those defined by the IFRS. To facilitate the transition from existing reporting systems to the IFRS, regulators required companies to publish a complete set of 2004 accounts in IFRS format as well as in their habitual (local) format. To lower the cost of this initiative (it is very expensive for companies to switch from one standard to another), managers were given th echoice of whether or not to apply certain IFRS directives to their 2004 accounts. The 2004 financial reports of French companies show that they did their best to minimize the impact of IFRS on their figures. Although standards had changed, accountants did everything they could to prevent changes in the portrait of their financial status!


IMPACT OF THE SWITCH TO IFRS ON FINANCIALINFORMATION

It is still too early to measure the impact of the change to IFRS on financial information, but for the time being, the quality of financial reporting has clearly not improved significantly. This is as true in France as it is elsewhere in the world. The advantages of the IFRS are likely to be revealed in the longer term. Correctly applied, they should facilitate economic exchange and cross-border mergers, and they should lead to greatly improved financial information quality.


HOW TO IMPROVE THE SYSTEM

 The reliability of financial information ultimately depends less on standardized reporting schemes than on regulation and institutional quality. Account reporting is important, but it is only one aspect of financial information. Financial supervision is currently insufficient on the European level, and it has become crucial to create European business legislation to ensure that EU stakeholders all benefit from the same rights and opportunities. This is the real issue behind demands for greater economic regulation, and the issue is as pertinent as ever before. The current recession has made economic actors realize that accounting is far more than a technical matter. Financial reporting is anything but neutral; it has a direct impact on a company’s development potential and therefore on the economy as a whole.


 *The IABS was created in 1973 by accounting institutes in 10 countries, including France, in an aim to provide internationally applicable accounting standards.


Based on an interview with Thomas Jeanjean andon his articles, “IFRS 1: il faut tout changer pour que rien ne change”(Changing Everything So That Nothing Changes), co-authored with AnneCazavan-Jeny, Comptabilité – Contrôle – Audit , 2007; and “Do AccountingStandards Matter? An exploratory analysis of earnings management before andafter IFRS adoption,” co-authored with Hervé Stolowy, Journal of Accounting and Public Policy , 2008.

BUSINESS APPLICATIONS
BUSINESS APPLICATIONS

The generalized adoption of IFRS is primarily a concern for financial analysts and those who interpret businesses financial statements. Still, Thomas Jeanjean’s research shows that adopting a set of common standards is not enough to ensure the good health of a company. The only way to ensure a company’s financial stability is effective governance, plus incentivized schemes that encourage top management to improve their organization’s performance. 

METHODOLOGY
METHODOLOGY

“IFRS 1: Il faut tout changer pour que rien ne change” (Changing everything so that nothing changes) is based on a study of French SBF 120 indexed companies. For each company, the following data was collected: size indicators, debt, performance indicators, and industrial sector. Information came from the following three sources: each company’s 2004-2005 annual report, Thomson One Banker’s Extel database, and the Compustat-Global Vantage database. “Do Accounting Standards Matter?” is based on study of the application of IFRS in three different economic environments—France, the UK, and Australia. All three of these countries adopted IFRS for the first time in 2005.