IFRS has been developed to facilitate the integration of capital markets. The benefits arising from IFRS adoption, including reduced costs of capital and more liquid market, can only be obtained by "serious" adopters. Other than these two benefits, the convergence to IFRS provides more accurate analyst forecast, especially for mandatory adopters.
In the process of implementation, IFRS is unlikely to improve the quality of a country's financial reporting if there are strong political influences. Additionally, the European adopters are encountering a number of challenges. Finally, accountants and auditors have to acquire additional expertise to provide more professional judgment under IFRS.
The integration of capital markets has pushed the development of IFRS (Scott, 2009). The wide adoption of IFRS across different countries brings about reduced costs of equity capital, more liquid market and more accurate analyst forecast, as specified in Section I. It should be noted that the magnitude of these positive effects differs among companies and countries. Section II reinforces one of Scott (2009)'s argument that IFRS adoption is subject to each country's political influences. Section III includes a number of difficulties and challenges faced by countries and their firms when IFRS is implemented.
I. Economic Consequences of Adopting IFRS
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Scott (2009) listed two benefits of adopting IFRS: the lower costs of equity capital and increased market liquidity. While Hail, Leuz and Wysocki (2010) acknowledged these benefits in their research, they stressed that the magnitude of these positive effects "varied significantly across firms, industries, markets and countries" (p. 580). In some extreme cases, the adoption of IFRS may even bring about negative consequences. For example, Daske (2006) studied a considerable number of German firms that had adopted IFRS and found that the cost of equity either remained the same or even increased after IFRS adoption.
Daske, Hail, Leuz and Verdi (2007) studied a sample of firms from 30 countries and suggested that the market liquidity and cost of capital effects arising from IFRS adoption depended on "individual firms reporting incentives and actual reporting behavior" (p.335). To demonstrate this, Daske et al. (2007) tested these effects on serious and label adopters, respectively. Serious adopters are those companies who have strong desirability to improve their accounting transparency and thus have experienced material changes in their reporting by IFRS adoption (Daske et al., 2007). In contract, label adopters are those companies who adopt IFRS "merely as a label" and thus have not experienced material changes in their reporting (Daske et al., p. 332). Daske et al.'s study (2007) found that only serious adopters had experienced an increase in market liquidity and a drop in the cost of capital.
Apart from the two benefits identified by Scott (2009), the study by Horton, Serafeim and Serafei (2008) stated that the convergence to IFRS could increase comparability between different firms' financial status and produce higher quality information, thereby improving analyst forecast accuracy. Horton et al. (2008) studied all firms from countries within the coverage of Institutional Brokers' Estimation System, where different analyst estimates for any given stock are accessible to investors. Further research indicated that the magnitude of error reduction was much greater for mandatory adopters as compared to voluntary adopters (Horton et al., 2008). Also, the improvement in accuracy was more significant for firms with accounting treatments that differ from IFRS to a large extent (Horton et al., 2008).
II. Political Effects on IFRS Adoption
Scott (2009) stated that a country's institutional structures could impair its quality of financial reporting even after IFRS is adopted.
Ball, Robin and Wu (2000) testified this argument by their empirical research on a number of Chinese domestic firms with foreign shareholders. These firms were required by Chinese government to report under IFRS (Ball et al., 2000). Ball et al. (2000) found that the high quality financial reporting supported by IFRS was mitigated by the country's institutional environment that was subject to strong political influences from Chinese government and army in the economy. As such, these Chinese firms failed to recognize economic gains or losses in a timelier manner as compared to their financial reporting under local standards (Ball et al., 2000).
Ball (2006) also found that Continental European countries encountered the same disability in improving their quality of financial reporting even after IFRS was adopted because of their code-law institutional structures. This is consistent with the findings of Ball, Kothari and Robin (2000)'s research as mentioned by Scott (2009).
III. The Difficulties and Challenges in Implementing IFRS
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Larson and Street (2004) surveyed a great number of firms in 17 European countries which had employed IFRS and concluded that there were five challenges faced by sample firms in the process of implementation. These challenges came from the "complicated nature of particular accounting treatments under IFRS" (e.g. the treatment of financial instruments), "alignment between financial accounting and tax reporting", "underdeveloped national capital markets", "insufficient guidance on first-time application of IFRS", and "limited experience with certain types of transactions (e.g. pensions and other post-retirement benefits)" (Larson & Street, 2004, p. 89).
To obtain a reliable fair value for a particular security or an asset, as required by IFRS, is another challenge companies may face (Ball, 2006). Even if a fair value can be obtained directly from the market, the spread (i.e. "the difference between the bid and the ask price" of a security or an asset) can be significantly large, which increases the uncertainty about fair value and introduces noise to the financial statements (Ball, 2006, p. 377). When there is no market value for reference, the fair value is subject to managers' estimation, which increases the possibility of earnings management (Ball, 2006).
Finally, IFRS relies on a principles-based system that provides more flexibility for countries to set accounting standards in compliance with IFRS (Carmona & Trombetta, 2008). Such system requires accountants to grasp a comprehensive understanding of the economic fundamentals of transactions and events before deciding on a particular accounting treatment (Carmona & Trombetta, 2008). Meanwhile, as mentioned by Scott (2009), auditors are obliged to provide professional judgment to ensure that accounting standards are properly used. The accountants and auditors in countries with a rule-based system, such as U.S., may face substantial difficulties when switching from one system to another (Carmona & Trombetta, 2008).
Given the limited condition under which the benefits of IFRS can be realized, political factors that may damage the financial quality of IFRS and a number of challenges faced by managers and accounting professionals, it will take a long time and considerable effects for different countries and firms to fully converge to IFRS and utilize this set of high quality standards to benefit their investors.