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The Effects of International Financial Reporting

Standards on the Accounts and Accounting


Quality of Australian Firms:
A Retrospective Study
John G o o d w i n " * , Kamran A h m e d b * and Richard H e a n e y c *
"TheHong Kong Polytechnic University
bLaTrobe University
'RMIT University

Received September 2007; Accepted June 2008

Abstract
We examine the effect of Australian equivalents to International Financial Reporting Standards
(IFRS) on the accounts and accounting quality of 1,065 listed firms, relying on retrospective
reconciliations between Australian Generally Accepted Accounting Principles (AGAAP) and
IFRS. We find that IFRS increases total liabilities, decreases equity and more firms have earnings
decreases than increases. IFRS earnings and equity are not more value relevant than AGAAP
earnings and equity and while adjustments for changes in accounting for provisions and intangibles
other than goodwill are value relevant, they weaken associations with market value. Goodwill
adjustments improve associations with market value. We also find that the reconciliation note for
the earnings adjustments contained no new information.
JEL Classi3cations: M40,M41
Keywords: LFRS, accounting quality

*Wethank participants at research workshops at The Hong Kong Polytechnic University, RMIT University,
The University of Technology Sydney, the AAA 2007 annual meeting, the AFAANZ 2007 annual meeting and
the JCAE/AJPT 2008 annual symposium for their valuable input. We also thank Eli Bartov, Kim Sawyer, Katherine
Schipper, the editors and the anonymous reviewer for their valuable input. Any errors remain the authors'.

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Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

1. Introduction
In 2002 the Financial Reporting Council (FRC) claimed that the implementation
of Australian equivalents to International Financial Reporting Standards (IFRS) would
enhance the overall quality of financial reporting in Australia (FRC,2002). This view
was supported by the Australian Accounting Standards Board (AASB) in suggesting that
complying with IFRS would not impose significant burdens and costs on entities when
compared with the benefits of more relevant and reliable information for users of financial
reports (Fenton-Jones, 2003,53). There was general agreement among commentators, the
firms, analysts and the wider community that the introduction of IFRS from 2005 would
materially affect Australian firms financial performance and accounts quality (Buffini,
2005; Clarke and Dean, 2005, Deegan, 2005,32-35). A study based on interviews of 60
senior financial executives from Australias top 200 firms reported that the introduction
of IFRS would have a significant impact on financial position and earnings. The majority
of executives expected earnings to be negatively affected while less than half expected a
positive effect on the financialposition of their firms (Jones and Higgins, 2006). However, no
substantialempirical study has been undertaken to assess the claim that financial statements
prepared under IFRS will enhance the quality of financial reporting in Australia or to
examine the effects of IFRS on financial performance. In this paper we use a representative
sample of listed firms in attempting to fill this gap in the literature.
Our study contributes to the current debate on whether IFRS based accounting numbers
are of a different quality to those produced under domestic GAAP in several important
ways. First, we examine all listed Australian firms that have available data. Second, the
exemptions from applying IFRS to restated earnings and equity are limited to a small
number of standards and all firms are required to restate and provide reconciliations from
Australian Generally Accepted Accounting Principles (AGAAP) to IFRS upon first-time
adoption of IFRS (AASB 1 First-Time Adoption of Australian Equivalents to International
Financial Standards, para 39): Prior studies use datasets that may not be representative
of the full effects of IFRS due to small sample size (e.g., Hung and Subramanyam, 2007)
or they may use firms that voluntarily adopt IFRS (e.g., Barth et al., 2005; Bartov et al.,
2005), meaning control for self-selection bias is needed. Self-selection bias is not an issue
with our dataset because early adoption is not permitted (AASB 1). Third, our large sample
size permits an empirical examination of the reconciliation adjustments to IFRS, which
has not been reported in the literature. Finally, examining the switch to IFRS for Australia
is useful, as similar studies have focused on code law countries such as Germany. In
Germany, accounting numbers are more conservative and have different value relevance
than accounting numbers produced under common law based countries like Australia (Ali
and Hwang, 2000; Ball et al., 2000).
IFRS is applicable for reporting periods beginning after 31 December 2004 and firms
are required to restate comparatives and provide reconciliationsto IFRS in their notes to the

Supporting this contention are the shareholder briefings held by some firms (e.g., Telstra and Alinta) to
explain the financial impact of IFRS on their accounts.
* There are some standards exempt from retrospective application, namely the two financial instruments
standards (AASB 132 and AASB 139),AASB 3 Business Combinations and the three insurance standards (AASB
4 Insurance Contracts,AASB 1023 General Insurance Contractsand AASB 1038Life Insurance Contracts).

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Journal of Contemporary Accounting & Economics VoE4,No 2 (December 2008) 89-119

accounts in the first year of adoption.This requirementpermits a research design that directly
compares accounting numbers and their properties prepared under AGAAP with those
under IFRS for the same set of firm-years, as firms provide earnings and equity amounts
measured under two different sets of accounting standards for the same periods.
Our investigation comprises two main parts. First, we document the effect of IFRS on
key accounting numbers and ratios. Using a sample of 1,065 listed firms, we find that the
mean (median) of total liabilities has increased and the mean (median) of total equity has
fallen. Total assets and earnings are higher under IFRS but the changes are not significant
apart from the increase in the half-year earnings median. IFRS increases the leverage ratio.
Second, we examine the relative value relevance of IFRS earnings and equity and the
incremental value relevance of IFRS over AGAAP. Using models with market prices and
returns as dependent variables, we carry out our tests on annual earnings (net income) and
equity measured at the changeover date to IFRS. We find no evidence that IFRS earnings
and equity are more value relevant than AGAAP. We find weak evidence that the aggregate
changes for earnings and equity are incrementallyvalue relevant to AGAAP.About half of
the reconciling adjustments to AGAAP are value relevant but are generally not timely. The
intangibles and provisions adjustments in particular weaken the association with market
value. Goodwill adjustments improve the association with market value.
Because our data is from retrospective reconciliations, the tests are only of the ability
of accountingnumbers to capture information used by the market. Therefore a coefficients
significanceprovides a lower bound on its true significance.We are aware of two other
similar papers, namely Rees and Elgers (1997) and Hung and Subramanyam (2007)
that examine a retrospective dataset. In our final test we examine whether the earnings
adjustments are associated with market values measured over the interval covering the
release of the IFRS reconciliation note. This test permits inferences about the usefulness
to investors of the reconciliation adjustments, as observing a significant coefficient in
this regression could result from investors using that information. We find that all of the
information in the earnings adjustments was impounded into prices before the release of
the accounts, suggesting that the market was able to obtain the information from sources
other than the reconciliation note.
The remainder of this paper is organised as follows. The literature review is covered
in the next section. Section 3 describes the institutional background and data collection
process. Section 4 describes the accounting differences between AGAAF and IFRS for the
major reconciliation adjustments and provides an examination of the effects of IFRS on
the accounts and on financial statement elements and ratios. Section 5 covers methodology
and results for relative value relevance tests and incremental value relevance is covered in
section 6. Section 7 concludes the paper.
2. Literature Review

Barth et al. (2005) use data from 24 countries over a 15-year period to 2004 and find that
the transition to IFRS results in improved accounting quality using a variety of measures.
Specifically, they find that IFRS results in more timely recognition of losses and higher
R2s in regressions of market value on earnings and book value. A study using European
data by Armstrong et al. (2007) report that the stock market reacts positively to the early

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Journal of Contemporary Accounting & Economics Vol4,No 2 (December 2008) 89-119

adoption of IFRS, which suggests that European equity investors perceive net benefits due
to convergence of accounting standards and improved information quality following IFRS
adoption.While these results may be more representative of the overall effects of IFRS, they
are difficult to interpret for a study examining one country because each set of domestic
GAAP is likely different in a number of respects. For example, the timeliness characteristic
of earnings differs according to the institutional environment between countries (Ball et
al., 2000): The most closely related studies to the present study are those that examine
samples from one country.
An early single-country study by Kinnunen et al. (2000) exploits a unique market
setting in Finland, where foreign investors are restricted in their trading of certain shares.
This permits the authors to examine the relative value relevance of Finnish GAAP and
voluntarily adopted IFRS between two investor groups. They find IFRS improves the
information content for foreign investors but not for domestic investors. Another Finnish
study by Niskanen et al. (2000), examines components of reconciliations to IFRS for
18 Finnish firms voluntarily using IFRS over the period 1984 to 1992. They report the
aggregate earnings difference is value irrelevant for explaining returns but that untaxed
reserves adjustments and consolidation differences are value relevant. Since these papers
examine voluntary adopters the results may be affected by self-selection bias and they use
a dataset of accounting rules that is dated!
More recently, Christensen et al. (2007) have examined the economic consequences for
UK firms of the European Unions decision to impose mandatory IFRS. They show that
there are cross-sectionalvariations in both short-run market reactions and long-run changes
in cost of equity associated with the decision, suggesting that mandatory IFRS adoption
does not benefit all firms in a uniform way but results in winners and losers. Using a price
levels regression, Hu (2003) reports that Chinese GAAP is more value relevant than IFRS
using a sample of 252 firm-years. This finding is supported by Eccher and Healey (2003),
who investigated a sample of 83 Chinese firms that were required to provide two sets of
accounts using Chinese GAAP and IFRS, and found that earnings under Chinese GAAP
were more closely associated with returns than earnings under IFRS.
Hung and Subramanyam (2007) use a sample of 80 German firms which voluntarily
adopted IFRS over the period 1998-2002and provided accounts under German GAAP and
IFRS for the same period. Using price levelsmodels, they find that total assets and book
value of equity, as well as variability of book value and net income, are higher under IFRS
than under German Accounting Rules (HGB). They also find that book value of equity
and net income under IFRS are no more value relevant than the amounts under HGB.
Further, they report that earnings and equity under IFRS are incrementally value relevant

With respect to a countrys institutional environment, Ball et al. (2000) report that due to different levels
of conservatism, earnings of firms in common law based countries are more timely in impounding economic
information than earnings of firms in code law countries. They also find that earnings coefficients are larger for
code law than for common law countries.
Other studies on the voluntary adoption of IFRS investigate the distinguishing economic characteristics of
firms that switch to IFRS. El-Gazzar et al. (1999) report that firms voluntarily adopting IFRS are those seeking
to access foreign capital, improve customer recognition or reduce political costs. Lang et al. (2003) note that
firms electing to adopt IFRS early are more likely to be those firms with fewer reconciling items.

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to German GAAP. Both coefficients are highly significant but the earnings coefficient sign
is negative which they suggest is consistent with more measurement errors in the IFRS
earnings than in the German earnings. Their relative value relevance results contrast with
Bartov et al. (2005) who also compare German HGB with IFRS (and US GAAP). They
find that IFRS is more value relevant than German HGB in its ability to explain returns (as
opposed to prices used by Hung and Subramanyam,2007). They also find little difference
in the value relevance of US GAAP earnings and IFRS earnings after self-selection bias
is controlled for?
Bartov et al. (2005) examine firms in the cross section rather than the same set of firms
as do Hung and Subramanyam (2007).The present study also examines the same firms with
the added advantage that firms must adopt IFRS rather than voluntarily.Although Hung
and Subramanyam (2007) control for self-selection bias, the possibility remains that the
bias in the IFRS accounts due to the effects of early voluntary adoptions may explain the
conflicting results, as Barth et al. (2005) have noted. Different models might be another
reason, which motives us to estimate both a price levels model and a returns model.
In sum, the literature gives conflicting evidence on accounting quality. Our study adds
to the existing literature on the effects of adopting IFRS on earnings and equity quality by
using recent data from companiesthat are required at initial adoption to provide earnings and
equity numbers under both AGAAP and IFRS, and by using price and returns models.

3. Institutional Background and Data


Australian firms are required to use IFRS for reporting periods beginning on or
after 1 January 2005. As part of the transition to IFRS,AASB 1 requires retrospective
reconciliations to IFRS earnings and equity to be provided in the first half yearly accounts
using IFRS and the first annual accounts using IFRS.For instance, in its annual accounts
ended 30 June 2006, the firm is required to provide a reconciliation of its annual AGAAP
earnings to IFRS earnings for the year ended 30 June 2005 and of its AGAAP equity to
IFRS equity at 30 June 2005.6 These data permit an examination of the major differences
between AGAAP and IFRS earnings and equity both in aggregate and for specific
reconciliation adjustments.
Our final sample of 1,065 firms is determined in a series of steps. First, all firms listed
on the Australian Stock Exchange are selected from Aspect Huntley Pty Ltds FinAnaZysis
database as at January 2006 which gives a total of 1,714firms. From these, 180 are deleted
because they were listed in 2005 or 2006; 72 because they used non-Australian GAAP
or foreign currency; 73 because they were suspended from trading and their accounts are
not available; and two because they were delisted prior to account lodgement. This gives
a potential sample of 1,387 firms. We then examine the notes to the annual accounts and

Leuz (2003) also examines the value relevance of German accounting numbers and reports that neither the
trading spread nor the trading volumes is significantlydifferent for the companies that choose IFRS or US GAAP
voluntarily.
Another requirement is to provide a reconciliation to half-year IFRS earnings (net income) to December
2004 in the half-year accounts ended 3 1 December 2005. These dates are different for a firm with a year-end that
differs from June 30 (see paragraphs 39 and 45 of AASB 1 for other requirements).

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record details of any reconciliations for annual net income and equity at the last date that
AGAAP is used.
We delete 280 firms which were unaffected by IFRS and 42 firms with missing data
or identified as outliers in initial regression tests. In the final sample of 1,065firms there
are 1,020firms with earnings changes and 844 firms with equity changes. Table 1 shows
the sample description.

Table 1

Sample Description
Number of firms listed on ASX at January 2006
Less:
Firms listed in 2005 or 2006
F m s using foreign currency / foreign GAAP
Accounts not available
Firms delisted in 2006
Potential sample
Financial
Non financial
Mining

1,714
( 180)

(72)
(73)
(2)

1,387

18%
47%
35%

253
649

485
1,387

Less:
Unaffected by IFRS
Firms with missing data
Final sample
Financial
Non financial
Mining

(280)

3
1,065
18%
50%
32%

193
530

3
1,065

Firms with earnings changes


Firms with equity changes

1,020
844

4. Major Accounting Differences and Their Effects on the Accounts


In this section we describe the main accounting differences between AGAAP and IFRS
for major adjustments, discuss the main reasons for each adjustment, and present evidence
of their effects on the accounts.
4.1 Major accounting differencesand adjustments
Table 2 shows frequencies and percentages of unsigned AGAAP earnings and equity of
the nine most common reconciling adjustments for earnings, and for a catch-all component

Of the 280 unaffected firms, 15 firms changed comparatives only for prior period errors and accounting
policy changes unrelated to IFRS .AASB 108Accounting Policies, Changes in Accounting Estimates and Errors
requires retrospective adjustment for these types of change (para 19 and 42).

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Table 2
~

Frequencies and Percentages of Unsigned Earnings and Equity for Adjustments of Earnings and Equity

N
Share-based payment
Income tax
Goodwill
Intangibles
Provisions
Investments
Impairment
FX translation
Leases
Other
Total

594
456
38 1
183
165
131
98
98
90
353
1,020

Earnings
Mean%
-341
40
9
-3

75

Median%
-3
0
9
1
-1
6

-54
-4
-4
-16

0
-1

-1

0
0

N
83
415
315
194
174
94
120
84
84
361
844

Equity
Mean%

Median%

-4

0
3
-11
-1
5
-12
-1
-1

-9
-6

-1
0
1
-1
0

0
-4

0
0

-1
-1

Earnings is annual net income. Equity is net assets. Mean % (median %)is the mean (median) of the reconciling
adjustment amount for earnings or equity divided by the absolute value of AGAAP earnings or AGAAP equity
for each firm.Other is a catch-all component.

- other? A summary of accounting policy differences between AGAAP and

IFRS is

shown in Appendix A.

Share-basedPayment: Under IFRS ,AASB 2 Share-based Payment requires expensing


of the fair value of equity granted. The prevalence and effect of this adjustment is due
to the popularity of equity schemes and the almost complete lack of equity payment
expensing prior to IFRS. The recognition of the expense for some small firms is highly
material (untabulated), thus the mean of -34 percent is much larger than the median of -3
percent. Because the accounting is equity neutral, the number of adjustments to equity is
much smaller than for earnings. The negative adjustments to equity are mainly caused by
derecognition of loans to employees to acquire shares and derecognition of the entitys own
shares held in trust for employees (treasury shares) under AASB 132Financial Instruments:
Disclosure and Presentation. We classify these types of treasury share adjustments here
because it presents a clearer picture on the effects of employee share scheme accounting.
Other adjustments for treasury shares are included in financial instruments below.
Income Tax: The balance sheet method of income tax accounting is used under
AASB 112 Income Taxes compared with the income statement method under AGAAP.
The principal difference is that the tax effects of items that bypass the income statement
are not recognised under AGAAP. Consequently, common adjustments relate to asset
revaluations, which give rise to deferred tax liabilities (DTLs), and share issue costs in
share capital, which give rise to deferred tax assets (DTAs). Raising DTAs for the tax
effects of share-based payments expenses is common since these expenses were usually
unrecognised under AGAAP, hence the positive mean. DTLs recognised for intangibles
*Thefirms disclosures are used to guide classifying the adjustments.

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that have indefinite lives are also quite common.


Goodwill: Amortisation over a period not exceeding 20 years under AGAAP is
replaced by an annual impairment test under AASB 3 Business Combinations. The result
is that firms have an increase in earnings and in equity on transition to IFRS. Hence the
means and medians are positive for earnings and equity in Table 2. Several firms wrote
off the balance of goodwill at transition due to impairment and these are classified under
impairment below. As with share-based payments, small firms are the cause of the large
mean of 40 percent relative to the median.
Intangibles: Under AGAAP, acquired and internally generated intangibles can be
capitalised and revalued provided that the value is reliably estimable9. Under AASB
138 Intangible Assets only acquired assets and development costs can be capitalised and
revaluation is only available for assets with an active market, with the result that most
intangibles are carried at cost. Assets are amortised under both AGAAP and IFRS although
amortisation can be avoided under IFRS if the asset has an indefinite useful life.
Except for development costs, it is clearly more difficult to capitalise intangibles and
measure them at fair value under IFRS than under AGAAP. Under IFRS development
costs can be capitalised provided the benefits are probable.lo Under AGAAP, research and
development (R&D) costs can be capitalised provided the benefits are beyond reasonable
doubt, which represents a higher hurdle than probable. However, there are specific
criteria to be met for capitalisation under IFRS, meaning the change in reporting bias is
ambiguous for these assets.
As a result of applying AASB 138 retrospectively, some firms have derecognised
their R&D asset and reversed its associated amortisation; and other firms have capitalised
development costs, which they had immediately expensed under AGAAP. In the first case,
at transition to IFRS the firm has a negative equity effect and typically a positive earnings
effect, and in the second case those firms have positive earnings and equity effects. Most
adjustments ke of the first kind, thus Table 2 shows positive median adjustments to earnings
and negative median adjustments to equity, most of which relate to R&D. Derecognition
of other intangible assets occurs because those assets are not measured by reference to an
active market. Examples include brand names, trademarks and publishing rights and titles,
which can be very large, hence the mean of -11 percent.
Provisions: This adjustment includes initial recognition of costs restoration provisions
for leasehold improvements and assets under operating leases under AASB 137 Provisions,
Contingent Liabilities and ContingentAssets. Previously, these costs were recognised on a
cash basis except for mining firms, but under AASB 116 Property, Plant and Equipment,
the cost of an asset includes the cost of restoration. The re-measurement of AGAAP
provisions for mining firms on a discounted basis gives positive equity adjustments for
these firms, although the fair valuing of provisions under IFRS generally leads to negative
adjustments. Other positive adjustments are reversals of general provisions disallowed
under AASB 137, such as doubtful debts and restructuring provisions typically recognised
in a business combination, and reversals of provisions for dividends.

Recognition of internally generated goodwill was prohibited under AGAAP.


Probable is generally accepted to be more than 50 percent likely.
Mining firms measured the provision on an undiscounted hasis however.

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91

Investments: Revaluations of property are recognised in the income statement under


AASB 140 Investment Property, but under AGAAP such revaluations were recognised
directly in equity. This is the underlying reason for the large difference between the
percentage adjustment to earnings (75) and equity ( 5 ) . Also included in this adjustment
are re-measurement of investments in associates due to the collective effect of IFRS, and
equity investments classified as available for sale. Most adjustments are positive, but the
few negative adjustments are due to initial depreciation on investments reclassified to
property, plant and equipment, because those investments do not meet the definition of
investment under AASB 140.
Impairment: Under AASB 136 Impairment of Assets, firms are required to assess
non-current assets to determine whether the carrying amount exceeds the recoverable
amount, measured at present value. Under AGAAP, firms could choose to measure the
recoverable amount using undiscounted or discounted cashflows. More firms and firms
with large write-downs recognised impairments against opening equity at transition, as the
median of -4percent for equity versus a median of 0 percent for earnings suggest.
FX Translation:Under AGAAP, firms used either the current rate or temporal methods
to translate foreign operations accounts. Under AASB 121 The Effects of Changes in
Foreign Exchange Rates, firms are required to determine their functional and presentational
currencies and translate into Australian dollars at the rate current at balance date. The
result is that foreign exchange gains and losses on translation are now recognised directly
in equity until the investment is sold when the net of those gains and losses is recognised
in earnings. Non-monetary items are now translated at the current rate.
Leases: The main change under IFRS is the requirement to measure on a straight line
basis the expense for operating leases that contain payment escalation clauses. Previously
under AGAAP, lessees and lessors measured the expense on a cash basis. Lessees generally
have negative adjustmentsto earnings and equity indicatingunderexpensing in prior years.
Both lessees and lessors are classified here, so some adjustments to earnings are positive,
but most are negative.
Other: Other is a plug component necessary to complete the reconciliation from
AGAAP to IFRS. Included here are adjustments for financial instruments, prior period
errors and financial effects of changed accounting policies unrelated to IFRS.
The bottom row of Table 2 shows the overall mean (median) decrease to earnings
is 7(0)percent and to equity it is 6( 1) percent, consistent with a more conservative bias
under IFRS .
4.2 Effect of changes onjnancial statement elements and ratios

We next examine the effect of IFRS on financial statement elements, retained profits,
cash flow and ratios. The top three rows of Table 3 shows that assets, liabilities and equity
differ under IFRS, but only the liabilities and equity differences are significant at the 10
percent level. The mean of total assets has risen yet the median is unchanged, due to some
very large asset increases for a small number of firms. These increases are mainly due
to first time consolidation of mortgage trusts by financial industry firms, which has also
increased liabilities with a zero or small net equity effect. By contrast, the effect is clearly
upward (downward) with liabilities (equity) due to recognition of new liabilities, such
as deferred tax liabilities for asset revaluations and restoration provisions; remeasuring

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Table 3
Effect of IFRS on Financial Statement Numbers and Ratios

N
Total assets
Total liabilities
Total equity
Retained profits
Earnings
Earnings - half year
Net cashflow
Operating cashflow

ROE
ROA
TL I TA
Price earnings
Market to book

1,065
1,065
1,065
1,065
1,065
1,064
1,065
1,065
1,033
1,065
1,065
496
1,033

AGAAP
517.60
296.40
22 1.20
23.70
22.90
12.50
6.50
30.40
-0.24
-0.15
0.38
21.70
2.76

Mean
IFRS

t-test

AGAAP

Median
IFRS

529.30
342.30
187 .OO
13.60
24.40
13.20
6.10
3 1.40
-0.23
-0.16
0.41
21.56
3.23

0.49
0.02
0 .oo
0.01
0.11
0.21
0.27
0.21
0.73
0.19
0.oo
0.97
0.12

30.30
7.80
19.50
-3.90
0.10
-0 .o I
0.25
-0.07
0.01
0 .oo
0.31
10.95
1.71

30.30
8.20
18.50
-4.90
0.12
0.oo
0.25
-0.07
0.02
0.01
0.33
10.51
1.84

Wilcoxon
0.34
0 .oo
0 .oo

.oo

0
0.62
0.01
0.35
0.14
0.56
0.00

0 .oo

0 .oo
0.00

All balance sheet numbers are measured at the end of the last financial year reported under AGAAP. All
financial statement numbers are expressed in millions. ROE is earnings divided by equity at year-end. ROA
is annual earnings divided by total assets at financial year-end. TL is total liabilities. TA is total assets. Price
earnings ratio is calculated only for positive earnings for both AGAAP and IFRS.ROE and market to book ratio
are calculated on smaller samples because some firms (unincorporated trusts) report zero equity under IFRS.
P-values are for two-tailed tests

existing liabilities more conservatively, such as defined benefit superannuation plans; and
restoration provisions and reclassifications, such as equity to debt for trusts.I2
Both yearly and half yearly earnings have increased under IFRS, but the differences are
insignificant except for the half-year medians. Despite these trends more firms experience
an earnings decrease than an increase. This occurs because the dollar amount of the change
to earnings is about four times larger when it is positive. The main reasons for this are
unrealised gains on investments recognised in earnings under IFRS whereas those gains
were recognised directly in equity under AGAAP, and the reversal of goodwill amortisation.
The differences between operating and net cash flows are not significantly different.
With respect to the ratios the differences in means are insignificant with the exception
of leverage (TL/TA).The leverage median difference is also significant and indicates higher
accounting risk under IFRS.The ROA median is higher under IFRS,and the price earnings
ratio, which is measured only for positive earnings, is lower. The median difference of the
market to book ratio is higher reflecting much lower equity values. The results shown in
Tables 2 and 3 indicate that IFRS presents a weaker balance sheet for the average firm.

l 2 This latter reason is not expected to impact future reporting periods because trusts are presently amending
their deeds to circumvent the accounting requirement for trusts with limited lives to report zero equity.

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5. Relative Value Relevance


5.1 Methodology

Our second main objective is to examine the quality of IFRS-measured earnings and
equity.We adopt a value relevance perspective for accounting quality recognising that it is
but one of several perspectives (Schipper and Vincent, 2003).13Following similar studies
(e.g., Hung and Subramanyam, 2007), a price levels model based on Ohlson (1995), and
a returns model (e.g., Bartov et al., 2005) are used. In this section we compare in the cross
section the value relevance of earnings and equity measured using AGAAP and IFRS for
firms that report a net change from IFRS. These tests determine the relative abilities of
AGAAP and IFRS earnings and equity to capture information used by the market.
The price levels modelI4is:

where MV is the market value of the firms equity at the end of the last year that AGAAP
is used scaled by the number of shares at that time; E is the firms earnings for the last year
that AGAAP is used measured under AGAAP (denoted EA) or IFRS (denoted EI) scaled
by the number of shares at the end of that year; BVi, is the firms equity at the end of the
last year that AGAAP is used measured under AGAAP (denoted BVA) or IFRS (denoted
BVI) scaled by the number of shares at that time; and E is the error term.
We are also interested in examining the timeliness of the information contained in
AGAAP and IFRS-measured earnings. Our second model is:

where R is the annual raw return adjusted for capitalisation changes and dividends
measured to the end of the last year that AGAAP is used; E is the firms earnings for the
last year that AGAAP is used measured under AGAAP (denoted EA) or IFRS (denoted EI)
scaled by the market value of equity at the start of that period; and E is the error term.
A more common model includes earnings change as an additionalindependent variable
but data limitationsprevent us from using that model in the cross sectional comparison.We
do estimate that model in robustness tests in a longitudinal comparison (discussed below)
and inferences are unchanged.
Ball (2006) notes there is little settled theory or empirical evidence on which to build an assessment of
the advantages and disadvantages of IFRS despite the fact that almost 100 countries have adopted them.
I* Some studies (e.g., Easton, 1998; Easton et al., 2003) criticise scaling by the number of shares, arguing
that it may lead to spurious results due to the effects of scale. Barth and Clinch (2001) investigate the relative
efficiency of deflating methods in mitigating a scale effects model and find that the number of the firms outstanding
shares, as used in our study, is more efficient in mitigating scale effects.

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Because earnings releases contain information (Ball and Brown, 1968),value relevance
researchers often measure market value after the release of the accounts (e.g., three months
after fiscal year-end). However, in the present study this would bias the tests in favour of
AGAAP since the last AGAAP accounts are released before the measurement of market
value, and the IFRS reconciliation data are not released until the first IFRS accounts, which
is some months thereafter.Therefore, to place the two regressions on a more equal footing,
returns (and price) are measured at the end of the last year that AGAAP is used. Further,
as AGAAP half yearly earnings are released during the return interval used in Model ( 2 ) ,
which may introduce a bias favouring AGAAP, we also compare half yearly earnings using
model ( 2 ) and use 6-month returns. Results (untabulated) from this regression, discussed
in the robustness tests section below, leave inferences unaffected.
We assess accounting quality by comparing the explanatory power of the models
measured by the adjusted R2,using the test proposed in Vuong (1989). AGAAP regression
results are presented first so Vuongs (1989) Z-statistic is positive when the IFRS regression
is favoured over the AGAAP regression.

Table 4
Descriptive Statistics for Regression Variables
Panel A: Price levels regression (Model 1)

MV
AGAAPeamings
AGAAPequity
IFRS earnings
IFRS equity

Code

Mean

Median

StdDev

Min

Max

70Pos

MV
EA
BVA
EI
BVI

1,065
1,065
1,065
1,065
1,065

1.18
0.05
0.73
0.06
0.66

0.42
0.00
0.23
0.00
0.20

1.71
0.19
1.14
0.19
1.04

0.01
-1.42
-0.56
-1.02
-0.62

8.86
3.01
8.65
3.01
8.65

100
51
98
51
98

0.22
-0.07
-0.06

0.05
0.01
0.02

0.92
0.45
0.37

-0.95
-8.82
-4.68

7.84
1.68
2.06

55
52
52

Panel B: Returns regression (Model 2)

Returns
AGAAP earnings
IFRS earnings

R
EA
El

922
922
922

In Panel A, all variables are scaled by number of shares outstanding at the end of the last year that AGAAP is
used. In Panel B, returns are measured over the 12-month period ending on the last day that AGAAP is used and
all independent variables are scaled by market value of equity at the start of the last year that AGAAP is used.
Detination of variables are described as in the text.

5.2 Descriptive statistics

Table 4 shows descriptive statistics for the regression variables. As we estimate models
with different scalers, namely number of shares and market value of equity, two sets of
variables are shown in Panel A and B respectively. The second and third top rows of
Panel A show the mean (median) AGAAP earnings is $0.05 ($0) per share and for equity

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it is $0.73 ($0.23) per share. The mean and median IFRS earnings are similar to AGAAP
earnings but the equity mean and median are lower as Tables 2 and 3 suggest. The number
of observations reported in Panel B is lower than in Panel A since valid 12-month returns
are needed, thereby excluding recently listed and thinly traded stocks. The sample size
reduces to 922 from 1,065 for the returns model.

5.3Results
Panel A of Table 5 shows the price levels model results.In the cross sectional comparison
for the AGAAP regression, the coefficients for earnings and book value of equity are

Table 5
Relative Value Relevance of AGAAP and IFRS Earnings and Equity
Panel A: Price levels model
W,,,
= a , , + a , E t ,+a,BV,, + E,,

Vuong Z-stat
(p-value)

31.82** 0.68
26.24** 0.62

1,118.64
878.15

-1.44
(0.15)

32.92** 0.73
24.63** 0.60

1,336.35
730.65

-2.52
(0.01)

t-stat

Cross sectional comparison (N= 1,065)


AGAAP
0.34
9.52**
2.04 10.62**
IFRS
0.39
10.13**
1.95
9.01**

1.01
1.04

Longitudinal comparison (N = 972)


AGAAP
0.31
9.21**
2.44
IFRS
0.39
7.51**
2.10

1.06
1.19

t-stat

F-stat

BV

Constant

t-stat

11.44**
9.31**

Panel B: Returns model

4, = a,,+ aJ,,+ &,,


~

Constant
~~~~

(2)

~~

t-stat

t-stat

BV

t-stat

R2

F-stat

VuongZ-stat
(p-value)

Cross sectional comparison (N = 922)


AGAAP
0.24
7.84**
0.28
IFRS
0.24
7.84**
0.34

4.24**
4.28**

0.02
0.02

17.94
18.28

0.03
(0.98)

Longitudinal comparison (N = 744)


AGAAP
0.21
7.24**
0.21
IFRS
0.27
9.74**
0.18

3.01**
3.55**

0.01
0.02

9.03
12.59

0.30
(0.62)

E is annual AGAAPeamings, BV is book value of AGAAP equity at the end of the year. All independentvariables
are scaled by the number of shares at the end of the year in Panel A and by the market value of equity at the start
of the year in Panel B. Price is measured at the end of the last year that AGAAP is used in the cross sectional
comparison.Price is measured at the end of the respective financial year in the longitudinal comparison.Returns
are measured for the 12-month interval ending at the end of the last financial year that AGAAP is used in the
cross sectional comparison. Returns are measured for the 12-month interval ending at the end of the respective
financial year in the longitudinal comparison.** = significant at the 0.05 level (two-tailed test), * = significant
at the 0.10 level (two-tailed test)

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Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

2.04 and 1.01 respectively. For the IFRS regression the coefficients are 1.95 and 1.04
respectively. Both models are significant (p < 0.05) and the adjusted R2s are about 68
percent for AGAAP and 62 percent for IFRS ,suggesting possible higher value relevance
for AGAAP. However the Vuong (1989) Z-statistic of -1.44 is not significant (p = 0.15),
indicating no difference in explanatory power of earnings and equity for price. Since the
restated earnings and equity used in the cross sectional comparisons are not fully IFRS
compliant, it is possible that these numbers omit important information. Therefore, we also
estimate the models using IFRS fully compliant earnings and equity for the first year of
IFRS, and compare the results with those using AGAAP for the previous year, namely the
last AGAAP year. Inferences from these tests may be affected from time series variation,
however, which is unavoidable. These results are shown in the longitudinal comparison in
each panel and we lose some observations due to missing data. The Vuong (1989) Z-statistic
of -2.52 (p = 0.01) favours AGAAP earnings and equity over IFRS earnings and equity
in explaining price. AGAAP earnings and book value are more value relevant than IFRS
earnings and book value, ceteris paribus.
The returns model results shown in Panel B indicate no difference between AGAAP
and IFRS earnings timeliness (Z-stat = 0.03, p = 0.98). Both models explain about 2
percent of the variation in returns. With respect to the longitudinal comparison we find no
difference in explanatory power between the two models. Thus the price levels regression
results provide stronger evidence in favour of AGAAP than the returns results, suggesting
timeliness is unlikely to be worse under IFRS than under AGAAP.
5.4 Robustness tests

We test the robustness of the results by partitioning the sample by firm size, industry
and then by profitability and estimating the models on these samples, in cross sectional
and longitudinal analyses. These results are not reported in a table for parsim~ny.~
Commentators expressed concerns about the effect of IFRS adoption on small firms and on
certain industries. For example, in 2005,25 submissions were made to the Parliamentary
Joint Committee on Corporations and Financial Services (hereafter the Committee) inquiry
into Australian accounting standards detailing different views on the effects of IFRS.
Most of those submissions suggest that firm size may be an important discriminator for
accounting quality. For example, in a discussion paper submitted to the Committee of the
Australian Institute of Company Directors (AICD) stated: Smaller companies are at a
greater disadvantage in moving to IFRS than larger companies...,mainly because of lack
of resources (AICD, 2004). Statistics (untabulated) reveal that large firms experience
an increase in earnings while small firms experience a decrease, and large firms have a
decrease in equity while small firms have no change. The effects of IFRS are not symmetrical
across firm size, which may affect value relevance.16We split the sample firms based on
Results are available from the authors on request.
The main reason for the earnings differences is that write-downs of intangibles and recognition of share
based payments expense, while pervasive across firm sizes, are more material in small firms. Recognition of
unrealised investment gains in earnings and reversal of goodwill amortisation are each about six times more
common in large firms than in small firms. The negative adjustments to equity for unfunded superannuation
plans, employee loans under share schemes, reclassifications of equity to debt and intangible write-downs are
more common in large firms.
Is
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Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

median total AGAAP assets at the end of the last year that used AGAAP and re-estimate
both models for the cross sectional and longitudinal samples. None of the Vuong (1989)
Z-statistics are significant, suggesting there is no difference in accounting quality across
firm sizes.
Industry accounting differences may affect our inferences because IFRS effects are not
uniform across industries. For example, unreported statistics reveal initial recognition of
restoration provisions are more common in the non-financial group and re-measurement of
those provisions common in the mining sector; unrealised gains and losses on investments
recognised on earnings are about three times as common in the financial than in other
sectors; and the intangible adjustments are about twice as common across the non-financial
sector than either of the other two sectors. Accordingly, we divide our sample into three
main groups following Barth and Clinch (1998) and re-estimate the models for the two
samples. The only significant Z-statistic is for the cross sectional comparison for the
financial industry (Z-stat = 1.68, p = 0.09), which favours AGAAP over IFRS.
Loss-making firms may affect our inferences. Specifically, it is possible the comparisons
of accounting quality between the two samples are affected by different numbers or
materiality of losses, since losses reduce value relevance (Hayn, 1995; Collins et al., 1997).
Additionally, a more timely recognition of economic losses from initial recognition of
provisions and the more stringent asset impairment test under IFRS may result in higher
explanatoly power of earnings for returns under IFRS. We estimate the models separately for
profit only and loss only sub-samples. The Z-statistics indicate no difference in accounting
quality between the price levels or returns models.
5.5 Other Tests

Since we use price and returns at the end of the year, we estimate the regressions
using prices (returns) measured at (to) three months after reporting date. As noted above,
we acknowledge that for the cross sectional comparison this test is biased in favour of
AGAAP. Because the half-year AGAAP accounts are released within the annual return
measurement interval used in Model (2), we also estimate Model (2) with half-year returns
and earnings. Finally, we add earnings changes in a longitudinal comparison using annual
earnings, earnings changes and annual returns and then using half yearly earnings, earnings
changes and half yearly returns. No evidence is found that IFRS enhances accounting
quality in any of these tests.

6. Incremental Value Relevance


It is possible that IFRS improve accounting quality by capturing different information
~

between AGAAP and IFRS are more significant for large firms.
For example, in the cross sectional analysis for the price levels regression (untabulated), the 2-statistic is -1.34
(p = 0.18) for large firms, and it is -0.41 (p = 0.68) for small firms.
* The Z-statistic (untabulated) are more significant for profit samples than for loss samples. For example,
for the price levels regression, the Z-statistic for the cross sectional sample is -1.58 (p = 0.1 1) and for the
longitudinal sample it is -1.29 (p = 0.20).
However, we observed that the differences

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Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

to that captured by AGAAP accounting numbers, despite the results on relative value
relevance (Biddle et al., 1995). Therefore in this section we examine incremental value
relevance. Existing studies on the incremental value relevance of IFRS examine only the
total difference (e.g., Hung and Subramanyam, 2007).A shortcoming with these studies is
that one cannot be sure that IFRS provides incremental information since the components
of the difference are not tested. Specific adjustmentscan be value relevant and thus improve
our understanding of the quality of the recently introduced IFRS, when the total difference
is insignificant (value irrelevant). We examine the aggregate differences and the nine
most common adjustments of the earnings difference for earnings and for equity. These
latter tests are related to the literature examining the value relevance of specific pieces of
information, such as intangibles.

6.1 Testing aggregate differences


We first examine the ability of aggregate differences in earnings and equity to capture
information beyond that in the AGAAP measured numbers. Model (1) is adapted as
follows:
24

MV,, = a o +alEAi,+a2BVA,,+a,EDIFF,,,+a,BVDIFF,, + ~ a J N D , +E,,


,

(3)

1-1

where EDIFF is IFRS earnings for the last year that the firm used AGAAP disclosed
in the annual accounts less AGAAP earnings for the last year that the firm used AGAAP
scaled by the number of shares at the end of that year;19BVDIFF is IFRS equity at the end
of the last year that the firm used AGAAP disclosed in the annual accounts less AGAAP
equity at the end of the last year that the firm used AGAAP scaled by the number of shares
at the end of that year; and IND is a dummy variable that equals 1 if the observation is
from ASX industry number 1 through 24 and zero otherwise, for each industry 1 through
24, other variables are as defined above.
6.2 Testing the adjustments

To examine the ability of the adjustments to explain market value the following model
is estimated:
I0

10

24

Mi,
=a,, + a,EAi,+ a2BVAir+ ~ c ( , ~ E A U J+ ,~~a ,, , B V A D J , ,+ ~ a , , I N D+,
It-l

"-1

(4)

1-1

The adjustments are: share-based payment instrument (SHAI), income tax (TAX),
goodwill (GOO), intangibles (INT), provisions (PRO), investments (INV), leases (LEA),
I9 Reconciliations from the annual accounts are used because about one third of listed firms changed their
reconciliations in their annual accounts (Goodwin et al., 2008).

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Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

impairment (IMP), foreign exchange translation (FX)and other (OTH) is the catch-all
component. The adjustments and OTH sum to the aggregate differences between AGAAP
and IFRS except for SHAI. Since the measurement of the share-based payment expense
(SHA) includes the firms price, the variable SHA is correlated with the error term in
Model (4). We follow Aboody (1996) and Bell et al. (2002) and use the instrumental
variables technique. Specifically, SHA is replaced with the number of equity instruments
(e.g., options, shares) outstanding at the end of the year (scaled by the number of shares),
denoted SHAI. For consistency with the other adjustments, the sign of SHAI is coded
negative for an expense?O
We also use a returns design, which assesses the timeliness of information in the
adjustments by adapting Model (2) as follows:
24

R , =ao+ a,EAj,+ a,EDIFF;, + E C X J N D ~+ ,E ~ ,

(5)

where EDIFF is IFRS earnings for the last year that AGAAP is used disclosed in the
annual accounts less the AGAAP earnings for that period scaled by market value of equity
at the beginning of that period, and other variables are as defined above.
As with the price levels regression, the earnings differences are disaggregated and the
following model is estimated
10

R,

= a.

24

+ a,EA,, + ~ C ~ , , E A D+ ~J a~g~t I N D+i El ,

The adjustments in EADJ are measured identically to EADJ in Model (4) except that
the variables are scaled by the market value of equity at the start of the period and we use
the share-based payment expense (SHA) instead of the instrumental variable (SHAI). In
a robustness test, we replace SHA with SHAI and then with the number of instruments
granted during the year (scaled by market value) with the same inference as for SHA in
Model (6).
By drawing on prior literature, predictions for the signs of the adjustmentscoefficients
in the price levels model are offered. Market value is measured before release of the
reconciliation note containing the adjustments. Therefore, our predictions are based on
the assumption the market obtains the information from sources other than the note. In
another test conducted in the last section, we find that the information in the earnings note
contains no new information to the market.
Share-BasedPayment :The most closely related studies to ours are those examining
More recent studies also include option pricing inputs, such as expected volatility (e.g., Bell et al., 2002;
Aboody et al., 2004). However those studies examine only options. Share-based payment expense in this study
includes shares, options and performance rights, in some cases for the same firm,which makes that approach
problematic.

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Journal of Contemporary Accounting C? Economics Vol4, No 2 (December 2008) 89-119

disclosed or researcher estimates of employee stock options expense. Overall there is


mixed evidence, but more recent studies suggest disclosed options expense is regarded
as an expense by the market. For example, Aboody (1996) and Aboody et al. (2004)
find a negative relation with market value and Bell et al. (2002) find a positive relation.
Despite these studies, in our study a prediction for this coefficient is problematic for three
main reasons. First, share-based payment expense includes expenses for other equity
instruments granted, (e.g., performance rights and shares) and equity instruments granted
to non-employees (e.g., contractors), which may have different economic implications for
employee options. Second, our data is for recognised share-based payment. Third, our data
is the first year of recognising the expense. These last two reasons suggest that the reliability
of the share-based expense may be different to that when disclosed or when measured over
several years (Aboody et al., 2004). Thus we have no expectation for this coefficient.
IncomeTax: Several US studies find the net deferred tax adjustment and its components
to be value relevant (see for example, Amir et al., 1997; Amir and Sougiannis, 1999).
Barth and Clinch (1996) report a negative coefficient for the tax adjustment in a market
value relevance model for Australian firms reconciling to US GAAP. IFRS is similar to
US GAAP, but there are important differences (R&D accounting for example). Thus we
have no expectation for this coefficient.
Goodwill: Almost all adjustments are reinstatements of the goodwill asset, an asset
which prior US, UK and Australian research has found to be value relevant but not timely
(e.g.,Chauvin and Hirschey, 1994;Barth and Clinch, 1996).We expect a positive coefficient
for this variable.
Intangibles:Prior studies find that intangibles accounting under AGAAP captures value
relevant information (see, for example, Abrahams and Sidhu, 1998 for the R&D asset;
Goodwin and Ahmed, 2006 for amortisation of deferred costs, R&D and other intangibles;
and Barth and Clinch, 1998 for revaluations of most types of intangibles). These studies
results are consistent with investors regarding capitalised intangibles, including their
revaluation increment, as assets. Yet the new rules do not permit upward revaluation for
most intangibles, meaning that write-downs to equity have occurred at transition. Further,
omission of assets from the balance sheets and their associated amortisation from the
income statement will impede the matching of revenues generated with the costs. Using
US data, poor matching has been shown to reduce value relevance (see, for example, Lev
and Zarowin, 1999 for R&D and Amir and Lev, 1996 for investment costs). We expect,
given the more conservative rules under IFRS, that value relevant information will be
omitted from the accounts, resulting in a negative coefficient.
Provisions: Prior value relevance studies examining general provisions are sparse but
a developed US literature exists for banks provisions. These studies generally find that
provisions are negatively associated with market value (Barth et al., 1996; Eccher et al.,
1996). However the association is weaker when the element is not traded, which is the
case with provisions in our data set. Given that existing studies only examine one industry
and use overseas data, we have no prediction for this coefficient.
Investments: This adjustment comprises items that are expected to be positively
associated with market value (e.g., upward revaluations of property) and negatively
associated with market value (e.g., depreciation of property). Further, this component
comprises a number of investments in associate adjustments that are themselves composed

John Goodwin, Kamran Ahmedand Richard Heaney


107
Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

of a number of different adjustments (such as goodwill amortisation reversal). We have no


expectation for the sign of this coefficient.
FX Translation:A number of studies examine the value relevance of FX translation
adjustments giving mixed results, possibly because they do not consider the source of
the FX exposure (Pinto, 2005). More recent studies examining translation adjustments
from the current rate method find a negative association for market value relevance (e.g.,
Louis, 2003; Pinto, 2005). Given the mixed evidence, we have no expectation for the sign
of this coefficient.
Leases:We have no expectationfor the sign of this coefficient because we are unaware
of any research relevant to this adjustment.
Impairment: Several studies report that non current asset impairments are value
relevant (e.g., Elliott and Hanna, 1996;Francis et al., 1996;Deng andLev, 2006). However,
most studies use US data that do not include impairments of most intangibles. Further, the
impairment adjustment in our data set includes derecognition of intangibles at revalued
amount that likely contain value relevant information (e.g., Barth and Clinch, 1998), but
fail to meet the stricter valuation tests under IFRS. Deng and Lev (2006) for instance find
that impairments of acquired in-process R&D are not regarded as impairments by the
market because market participants seem to add back the impairment expense to the firms
earnings. Also, Francis et a1 (1996) report that inventory impairments are associated with
a negative market reaction but restructuring impairments are associated with a positive
market reaction. One might expect therefore that such omissions remove value relevant
informationfrom Australian firmsbalance sheets,We therefore expect a negative coefficient
for this variable. We have no expectation about the sign for the other coefficient.

6.3 Descriptive statistics


Table 6 shows descriptive statistics for the remaining independent variables. Some
variables are shown as zero because the numbers are rounded to two decimal places.
As shown in Panel A, the equity incremental variable (BVDIFF) mean is -$0.09 with a
minimum of -$5.08 and a maximum of $1 .lo, indicating the presence of some very large
negative effects on equity.These large decreases are mainly due to trusts reclassifying equity
as debt and derecognitionof intangible assets.The percentage of positive adjustments is less
than 50 for earnings and equity, indicating a downward bias from IFRS, caused mainly by
share-based payments for earnings and by a variety of different adjustments for equity.
With respect to the adjustments, about 98 percent of share-based payment adjustments
are negative because Australian firms rarely expensed equity instruments granted. About
97 percent of the goodwill adjustments are positive, as most adjustments are reversal of
amortisation. The variables scaled by market value of equity in Panel B show similar
relations to those in Panel A, although there are more positive earnings changes (51 percent)
than in Panel A (45 percent).

6.4 Results - aggregate differences


The price levels regression results presented in Panel A of Table 7 show that the AGAAP
earnings and equity coefficients are positive and significant, and the coefficients for the

Variable
IND13
IND14
INDI5
IND16
IND17
IND18
IND19
IND20
IND2 1
IND22
IND23
IND24

456
381
183
165
131
90
98
98
353

SHA
TAX
GOO
INT
PRO
INV
LEA
IMP
FX
OTH

No. Pos
7
27 1
31
67
77
30
2
72
26
24
19
13

0 .oo

0 .oo

0 .oo
0.00
0 .oo

0 .oo

0 .oo
0.01
0 .oo

-0.03

-0.05

594

0 .oo
0.02
0.oo
0 .oo
0.05
0 .oo
-0.02
0 .oo
-0.01

0 .oo

0 .oo

1,020

EDIFF
BVDIFF
SHAI

0.03
0.05
0.03
0.01
0.14
0.01
0.07
0.01
0.10

0.09

0.09

-0.23
-0.03
-0.24
-0.05
-0.53
-0.06
-0.51
-0.09
-1.11

-0.78

- 1.07

Earnings
Mean Median StdDev Mi0

0.34
0.74
0.08
0.06
0.82
0.02
0.09
0.03
0.46

0.01

0.82

49
97
63
25
70
33
48
50
36

45

Max %Pos

83
475
375
194
174
94
84
120
84
361

844

~~~~~

-0.02
-0.02
0.02
-0.08
-0.01
-0.01
-0.01
-0.07
-0.01
-0.14

-0.09

0 .oo
0 .oo
0.01
0 .oo
0 .oo
0 .00
0 .oo
-0.02
0 .oo
0.00

0.00

0.04
0.12
0.07
0.35
0.05
0.04
0.03
0.14
0.03
0.52

0.40

-0.24
-0.92
-0.08
-2.85
-0.58
-0.26
-0.30
-1.05
-0.27
-5.08

-5.08

Equity
Mean Median StdDev Min

~~

0.05
0.42
0.99
0.07
0.06
1.74
0.05
0.03
0.02
0.27

1.10

30
51
96
29
28
50
20
3
36
28

41

Max % Pos

All continuous variables are scaled by number of shares outstanding at the end of the last year that AGAAP was used. Definition of variables are described as in the text.

Continuous Variables
Earnings difference
Quity difference
Share-based payment
Instrument
Share-based payment
Tax
Goodwill
Intangibles
Provisions
Investments
Leases
Impairment
FX translation
Other
Dummy variables
Variable
No. Pos
10
INDl
IND2
6
IND3
63
44
IND4
IND5
17
IND6
26
IND7
103
IND8
71
IND9
4
INDlO
34
INDll
46
2
IND 12

Code

Panel A: Price levels regression (Model 3)

Descriptive Statistics for Regression Variables

Table 6

Code

Variable
IND13
IND14
IND15
IND16
IND17
IND18
IND19
IND20
IND21
IND22
IND23
IND24

15
11

18

No. Pos
6
237
28
58
67
25
2
64
21

922
5 14
399
348
158
153
120
81
93
87
316

N
0.01
-0.o1
0 .oo
0.02
0.oo
0 .oo
0.04
0 .oo
-0.02
0.oo
0.01

Mean

0
0

.oo
.oo
0.oo
0 .oo
0.oo

0.01
0 .oo
0.oo

.oo
.oo
0.oo
0
0

Median

0.50
0.05
0.06
0.05
0.08
0.01
0.16
0.oo
0.22
0.03
0.46

Std Dev

-8.54
-0.85
-0.24
-0.26
-0.80
-0.03
-0.36
-0.01
- 1.94
-0.10
-0.77

Min

3.70
0.02
0.83
0.52
0.53
0.04
1.23
0.01
0.41
0.15
7.85

Max

51
2
51
97
63
25
68
35
47
51
36

% Pos

All continuousindependent variables are scaled by market value of equity at the start of the last year that AGAAF' was used. Definition of variables are described as in the
text.

~~

-~

Continuous Variables
Earnings difference
EDLFF
Share-based payment
SHA
TaX
TAX
GOO
Goodwill
Intangibles
INT
Provisions
PRO
Investments
INV
Leases
LEA
Impairment
IMP
FX translation
Fx
Other
OTH
Dummy variables
Variable
No Pos
INDl
9
5
INDZ
IND3
57
IND4
41
IND5
17
IND6
23
IND7
86
IND8
56
IND9
3
INDlO
32
INDll
39
IND12
2

Variable

Panel B: Returns regression (Model 4 )

Table 6 (Cont.)

110

John Goodwin, Kamran Ahmedand Richard Heaney


Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

Table I
Results From Regressions of Prior Period Market Value on Prior Period Earnings, Equity and Current
Period Aggregate IFRS Differences
Panel A: Price scaled by number of shares as dependent variable (N = 1,065)
10

10

24

MV,, =a,+a,EA,,+a,BVA,,+C/a,,EADJ,,,+~a,,BVADJ,,,+~a,,lND,+E,,
"-1

t-stat

Constant
0.25
4.17**

n- I

EA
1.99
9.77'

BVA
1.04
27.33**

(3)

1- I

EDIFF
-0.21
-0.53

BVDIFF
0.14
1.41

R'
0.69

F-stat
87.87

R'
0.05

F-stat
3.05

Panel B: Returns as dependent variable ( N = 922)


24

R , = a o+ a,EA,t + a,EDIFF,, + Z a J N D , , + E,,


i- I
~

t-stat

Constant
0.29
4.96**

EA
0.35
4.17**

EDIFF
0.24
1.88*

EA is annual AGAAP earnings. BVA is book value of AGAAP equity at the end of the year. EDIFF is IFRS
annual earnings less AGAAP annual earnings. BVDIFF is IFRS book value of equity at the end of the year less
AGAAP book value of equity at the end of the year. Except for the industry dummies, all independent variables
are scaled by the number of shares at the end of the year in Panel A and by the market value of equity at the start
of the year in Panel B. Price is measured at the end of the last year that AGAAP is used. Returns are measured
for the 12-month interval ending at the end of the last year that AGAAP is used. Industry dummy variable results
are not reported for parsimony. ** = significant at the 0.05 level (two-tailed test), * = significant at the 0.10
level (two-tailed test)

earnings and equity differences are insignificant. The returns regression results shown in
Panel B show that the EDIFF variable is positive and significantat the 0.10 level, indicating
weak evidence of timeliness for the IFRS earnings difference. We examined the dataset
in attempting to reconcile these results. Estimating the price levels model on a constant
sample of 922 firms gave the same inferences. However, after removing the largest 20
observationsby market value from the constant sample,the EDIFF coefficientsare negative
and significant in both models and the equity difference is positive and significant in the
price levels model. This suggests that the insignificant results for earnings and equity
differences are due to a small number of influential observations.
6.5 Results - adjustments

Price Levels Regression:Table 8 shows results from estimatingthe price levels model
(Model 4). Coefficients for five of the ten earnings adjustments and for six of the ten equity
adjustments are significant.The equity adjustment for tax (TAX) is negative indicating that
those adjustments weaken associations with price. The coefficient for the goodwill (GOO)
adjustment to earnings is positive and significant suggesting that investors do not view
amortisation as a wasting asset. The IERS accounting policy of no amortisation improves
the association with market value over the AGAAP amortisation policy. However, the

John Goodwin, Kamran Ahmedand Richard Heaney


111
Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119
Table 8

Results From Regression of Prior Period Market Value on Prior Period Earnings, Equity and Current
Period IFRS Adjustments

Variable
Constant
AGAAP earnings
AGAAP equity
Share-based payment
instrument
Share-basedpayment
Tax
Goodwill
Intangibles
Provisions
Investments
Leases
Impairment
FX translation
Other
Industry dummies
R2

F-stat
N

Earnings
t-stat
Code Expect Sign Coeff
EA
BVA
SHAI

0.28
2.52

4.87
12.32

0.11

0.27

SHA
TAX
GOO
INT
PRO
INV
LEA
IMP

?
?

-1.85
7.39
-6.99
-46.55
-1.61
3.22
-4.27
4.34
0.08

-1.11
4.51
-2.51
-5.01
-2.57
0.19
-2.98
0.68
0.12
included
0.73
65.62
1,065

Fx
OTH

+
7
?
?
?
?

Equity
Expect Sign Coeff

t-stat

**
**
4-

0.83

19.42

-1.79
-1.34
1.01
-0.83
-3.18
0.01
-11.52
0.89
-6.06
0.21

-0.75
-3.07
0.96
-4.08
-2.02
0.02
-3.05
1.41
-1.71
1.95

**
**
**
**

+
?
?

**
?

**
**

**

**
**
*
*

MV,, is the market value per share measured at the end of the last year that AGAAP is used. EA is annual AGAAP
earnings for the last year that AGAAP is used scaled by the number of shares outstanding at the end of that
year. BVA is the AGAAP equity measured at the end of the last year that AGAAP is used scaled by the number
of shares outstanding at the end of that year. Other independent variables are as described in the text. Industry
dummy variable results are not reported for parsimony. ** = significantat the 0.05 level (two-tailed test), * =
significant at the 0.10 level (two-tailed test)

coefficient for the equity adjustment is not significant,which is puzzling. We removed the
15 negative goodwill adjustments to equity, and after estimating the model on the sample
of 1,050 firms this coefficient became significant at the 0.10 level. In this regression (N
= 1,050) there was no change in inferences from other variables apart from the 'other'
variable adjustment to equity, which became significant. As expected, the intangibles'
(INT) coefficients for earnings and equity are negative, suggesting that the changes to
accounting for intangibles under IFRS are inconsistent with investors' beliefs about the
value of intangibles.
Compared with AGAAP, intangible accounting under IFRS seems too conservative
when benchmarked against investors' beliefs. A similar argument is made by Amir and
Lev (1996) on the positive association between the immediately expensed investment costs

112

John Goodwin, Kamrun Ahmedand Richard Heaney


Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

Table 9
Results From Regressions of Prior Period Returns I Current Period Returns on Prior Period Earnings I
Current Period Earnings and Current Period IFRS Adjustments
10

24

-1

,-I

R,,=~,,+~,EA,+C~,,EADJ,,+C~,,~ND,,+E,
Variable

Code

Constant
Earnings
Share-based payment
Tax
Goodwill
Intangibles
Provisions
Investments
Leases
Impairment
FX translation
Other
Industry dummies

E
SHA
TAX
GOO
INT
PRO
INV
LEA
IMP
FX
OTH

R2

F-stat
N

Prior Period Returns


Coeff
t-stat
4.71 **
5.79**
-4.42**
0.05
3.36**
-1.50
0.22
0.47
-1.13
0.43
0.42
3.43 **

0.28
0.52
-3.47
0.06
3.07
-1.29
2.87
0.25
-36.43
0.26
I .46
0.49
included
0.08
3.46
922

Current Period Returns


Coeff
t-stat
0.51
0.19
-0.45
0.11
0.24
0.37
17.55
-0.21
-31.26
0.12
1.48
-0.02

9.46**
3.77**
-0.68
0.12
0.21
0.36
1.42
-0.57
-1.38
0.23
1.05
-0.21
included
0.09
3.29
744

Prior period return (R,) is the 12-month raw return measured to the end of the last year that AGAAP is used.
Current period return (Rit)is the 12-month raw return measured to the end of the first year that IFRS is used. E
is the annual AGAAP net income for the last year that AGAAP is used for the prior period returns regression
and E is the annual IFRS net income for the first year that IFRS is used for the current period returns regression.
Other variables are as described in the text.Al1 independent variables are scaled by market value of equity at the
start of the year. Industry dummy variable results are not reported for parsimony. ** = significant at the 0.05
level (two-tailedtest), * = significant at the 0.10 level (two-tailed test)

and market value for firms in the wireless communications industry? The coefficients
for provisions (PRO) for earnings and equity are both significant, suggesting that the fair
valuing of provisions is sufficiently reliable to be value relevant, but the negative signs
imply that the accounting is inconsistent with investors beliefs. The negative coefficient
for investments (INV) for earnings also suggests that investors view these adjustments
differently to the accounting policy. The coefficient for impairment (IMP) is negative
indicating that write-offs of different types of assets in earnings under IFRS polices are
also inconsistent with investor beliefs, although the equity adjustment is not significant.
We also re-estimated the price levels model on the same sample as the returns model (922
firms) and the results (untabulated) are consistent with the larger sample (1,065 firms).
Returns Regression: The returns model results, presented in the left half of Table
9, show that the model explains about 8 percent of the variation in returns and that the
21

In that paper the expense was coded as a positive number.

John Goodwin, Kamran Ahmedand Richard Heaney


113
Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-11 9

coefficient for AGAAP earnings is positive and significant (coeff = 0.52, t-stat = 5.79).
There are three other significant coefficients.The goodwill (GOO) coefficient is positive
and significant, which is consistent with the price levels model, indicating that these
adjustments are also timely. The coefficientfor SHA is negative and significant,indicating
a positive relation between share-based payment expense and returns. As a check on this
result, we replaced the variable (SHA) with the instrument used in the price levels model,
namely SHAI, and then with the number of instruments granted scaled by market value.
Both of these coefficients also indicate a positive relation with returns?* These results
suggest that the market does not view equity instruments granted as a period expense and
are inconsistent with the price levels model results. A possible explanation is that sharebased payments are regarded by the market as transitory. We leave further exploration of
this inconsistency to future research. The coefficient for all other items (OTH) is positive
and significant which is inconsistent with the price levels model. Compared to the price
levels model results, four coefficients became insignificant, namely INT, PRO, INV and
IMP, indicating that these variables are value relevant but not timely. Overall these results
indicate that much of the information in the reconciliationswas impounded in prices before
the release of the reconciliation note.
We are also interested in whether the reconciliation note provided new information to
the market, that is, whether the reconciliations are useful to investors. We acknowledge
that the usefulness to other users (e.g., creditors) is not considered by our tests. To examine
this question, we estimate Model (6)using returns measured over the 12-monthperiod to
the end of the first year of IFRS, replacing AGAAP earnings with IFRS earnings for the
first IFRS year.
Results, shown in the right half of Table 9, indicate that the IFRS earnings level
coefficient is positive and significantly associated with returns (coeff = 0.19, t-stat =
3.77). However, none of the coefficients for the earnings adjustments are significant.The
same inferences are also obtained if we use 12- or 15-month returns measured to the end
of the third month after the end of the first year of IFRS (untabulated). This suggests that
all of the information contained in these adjustments was impounded in price prior to the
start of the first year of IFRS. These reconciliation data contain no new information for
the market, casting doubt on the usefulness of the earnings reconciliation note. A similar
result is reported in Rees and Elgers (1997) in their examination of reconciliations using
US data.
7. Conclusion and Limitations

This paper provides evidence on the effects of IFRS on the accounts and accounting
quality for a sample of 1,065Australian listed firms.An important contributionof this study
is that we use a dataset of firms that must apply IFRS,which means that self-selectionbias
does not impact the results. We also examine a common law based country, which differs
from the code law based countries examined in most previous studies.
We find that under IFRS, mean (median) liabilities increase; mean (median) equity
z2 When we estimatethe price levels model using the same sample as for the returns mode1,theSHAI variable
coefficient becomes negative but remains insignificant.

114

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Journal of Contemporary Accounting & Economics Vol4, No 2 (December 2008) 89-119

decreases; there are more decreases to earnings than increases; and the leverage ratio
increases. Unrealised gains on investment property and reversal of goodwill amortisation
are the main drivers of earnings increases. Recognition of share-based payment expense
is the most common item decreasing earnings. Impairment is an important cause of equity
decreases. Write-downs of intangibles and reclassifications of equity to debt reduced equity
substantially but those adjustments are not pervasive.
No evidence is found that IFRS earnings and equity are of higher quality (more value
relevant) than AGAAP earnings and equity, consistent with other studies comparing within
country (Eccher and Healey, 2003; Hu, 2003; Bartov et al., 2005; Hung and Subramanyam,
2007). These results hold across subsamples of firm size, industry sector and profit- versus
loss-making firms. We find an instance of higher value relevance of AGAAP for the financial
industry. Our evidence is not consistent with the claim by the Financial Reporting Council
that IFRS will enhance financial reporting quality.
We also examine the incremental value relevance of the aggregate change and of
adjustments in reconciliations from AGAAP earnings and equity to IFRS earnings and
equity. Results show that in aggregate, the net changes to AGAAP earnings and book value
are not associated with prices and there is weak evidence that the incremental earnings
aggregate is timely.
Both the earnings and equity adjustments for intangibles are negatively associated with
price. This suggests that the change to IFRS accounting for intangibles is too conservative
when compared with AGAAP. We also find that the provisions, investments and impairment
adjustments are value relevant but not consistent with investors perceptions. These
adjustments are not timely however. We also find that the adjustment for share-based
payment is timely, and is not consistent with the markets perception.We find no association
of share-based payment with price. The goodwill component which comprises mainly
amortisation reversal is positively associated with market price and returns, consistent with
investors perceptions of value changes for this asset. We also find that foreign exchange
translation adjustments are negatively associated with market value, as do Louis (2003)and
Pinto (2005).Tests using returns measured over the period that the accounts were released
reveal that no information is contained in the earnings reconciliation note, suggesting that
this note is not useful to investors.
Apart from the usual limitations of studies such as ours, other limitations need to be
noted. Our cross sectional tests use a dataset that is not fully IFRS compliant, namely the
last year of AGAAP use. Tests on earnings and book value for the first year of IFRS use
provide consistent evidence. Nevertheless inferences may change when more periods of
IFRS are available. Relatedly, the first year of adoption of IFRS may increase incentives
to engage in earnings management, which may have a consequential effect for value
relevance. This is an interesting area for future research.

John Goodwin, Kamran Ahmed and Richard Heaney


115
Journal of Contemporary Accounting & Economics Val 4 , N o 2 (December 2008) 89-119

Appendix A
Summary of Major Accounting Differences Between AGAAP and IFRS
Share-based
payment

AGAAP
IFRS
No standard
Standard requires expenses for
Practice varies, most firms do
share based payments
not recognise expenses for share
based payments

Income tax

Income statement approach under Balance sheet approach


the standard
Tax losses recognised if benefits
Tax losses recognised if benefits are probable
are virtually certain

Goodwill

Must be amortised straight line up No amortisation


to 20 years

Intangibles other Can be capitalised and revalued Can only be revalued upward if
upward with increment to reserve active market
than goodwill
Must be amortised
Amortisation only if finite life
Restoration
provisions

No standard

Investments

Recognition of unrealised gains Recognition of unrealised gains


to recoverable amount directly in properties in income statement
equity

FX translation

Only current rate method

Temporal method current rate


method

Leases

Operating lease payment


expenses as incurred

Operating lease expense


calculated on a straight line basis
when agreements include fixed
rental increases

Revenue
recognition

Recognised over production


period

Recognised over period of street


life

Impairment

Non current assets must be


recorded at the higher of net
selling price and value in use if
lower than carrying amount

Non current assets must be


recorded at the higher of either
discounted or undiscounted
future net cashflows if lower than
carrying amount
Annual impairment testing
required for goodwill and
intangibles with infinite lives

Provision for restoration/


decommissioning costs required
to be recognised when criteria
satisfied

Source: Kemp and Knapp (2004);Nobes (2001)

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Journal of Contemporary Accounting & Economics Vol4,No 2 (December2008) 89-119

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