Mandatory Adoption of IFRS in EU in 2005

Introduction

The International Financial Reporting Standards (IFRS) comprised of a group of international accounting principles, the implementation of which aimed at creating clear policies within the European Union to prepare annual reports and financial statements that were transparent and comparable (Chen et al, 2010). The IFRS adoption characterized a fundamental element to attain an attractive, integrated and competitive capital market within the European Union, and this provoked the European Commission to establish a homogeneous set of accounting standards for listed EU companies. Regulation of the European Community needed the listed companies in the regulated markets to implement the IFRS standards for organizing their consolidated statements of accounts commencing from January 1, 2005.

The mandatory implementation of the International Financial Reporting standards (IFRS) marked a significant improvement towards a distinct set of efficient, high quality and internationally acknowledged accounting standards (Ahmed & Wang, 2010). IFRS was principally targeted at improving the quality of earnings and attaining a higher measure of financial statements comparability (Chen et al, 2010). Switching to IFRS signified a great deal of change in the firm’s accounting rules and practices and the firm’s major concern was to understand the extent to which the IFRS could have affected their performance

The IFRS transition was intended fundamentally for the transformation of the majority of European companies. IFRS has not been simply observed as an accounting practice, but as a transformation in the Generally Accepted Accounting Principles (GAAP) also in the entire financial reporting field. International Financial Reporting Standards information has impinged on firms’ perception on performance of businesses, and companies have been facilitated to prepare IFRS statements of accounts that mandate them to espouse a global financial reporting language as well as be assessed in a global marketplace (Daske et al, 2008

Based on the analogy that one language and currency led to greater economic efficacy in the United States, these benefits could still be accrued by the European Union through the adoption of the IFRS. The purpose of this adoption being the harmonization of accounting standards, and true to it has accrued benefits in this field on accounting to firms in the EU economic region. Maintaining a one language communication to stakeholders builds and develops their confidence in business and also develops finance raising abilities. IFRS permits firm’s benchmark themselves alongside their peers, as well as allowing investors compare the performance of firms globally with their competitors.

Business executives are shielded from common shocks effects arising from compensation contracts. These compensation contracts are beyond their power and thus endow them with motivation to apply effort to adopt the IFRS (Hung & Li, 2011 Nevertheless, before the compulsory implementation of IFRS, the disparity in standards of accounting may have barred firms from employing foreign people in accounting based on Rated Perceived Exertion (RPE). The mandatory adoption of the IFRS made the compensation committees regard earnings to be easy in comparison and increased foreign peers use in accounting related RPE for formulating executive compensation.

Wu and Zhang (2011) examined the impacts of the mandatory adoption of IFRS on the use of the Rated Perceived Exertion by European countries. The two studies portrayed a post adoption boost in usage of foreign partners in accounting-based RPE, and they present considerable evidence justifying that IFRS improves comparability in accounting.

IFRS adoption is just one aspect of a wider approach that raises a firm’s overall dedication to transparency and intelligibility (Daske, 2008). Therefore as Beneish, Miller and Yohn, (2009) explains, the impacts from the mandatory adoption of IFRS are liable to reveal disparities in the incentives for plausible reporting, the events that prompted the IFRS adoption and the total commitment stratagem to transparency. Along with the mandatory adoption of IFRS, companies may also be in quest of cross-listing in a stricter administration, to enhance corporate governance, raise extra capital and adjust structure ownerships. Thus, the impacts of the mandatory IFRS adoption are likely to transform firms largely but cannot be attributed only to IFRS.

Empirical literature suggests that there is increased use of firm’s earnings within the mandatory IFRS adoption which is principally driven by countries with big disparities between the local accounting standards and IFRS. Increased use of foreign peers is also evident in the accounting based RPE and this change in accounting is not motivated by the intensifying economic incorporation in continental Europe.

Generally, the idea of embracing internationally accepted standards in the European Union has been soundly accepted by companies and accounting professions. Conversely, disagreements have been witnessed within the EU over some standards that are considered controversial, specifically the IAS 32 and IAS 39.  The adoption of the IFRS would improve financial reporting to outside investors since IFRS are capital-market oriented and comprehensive information that is relevant to investors. This would lead to increase in market liquidity from foreign investments as well as the decline in firms’ costs of capital.              

IFRS also reduced the amount of disparities relative to many local GAAP and improved the quality of reporting. This was both an advantage and a disadvantage to managers in the sense that tightening the accounting standards could reduce the level of earnings management but also made it harder for managers to communicate private information through financial reports. It also made it easy for investors to compare firms across markets. This great comparability has made financial reports useful to investors and other stake holders. The same outsiders can detect earnings management and accounting manipulations and sets allowable accounting treatments which increases a firm’s reporting incentives.

Risk sharing is experienced when foreign investors move in to invest in a country because of the IFRS which facilitate cross-border investment and capital market integration. It is easier for foreigners to invest in a country’s firms if they can understand and compare financial results from different parts of the world. These have been made possible by the adoption of the IFRS, (Ball, 2006; Nobes, 2006; Christensen et al., 2007; Daske et al., 2007).

The bottleneck of the adoption of the IFRS was that firms that were against them were unlikely to make material changes to their reporting policies (Beneish, Miller & Yohn, 2009). This meant that in cases where firms were not willing to implement the IFRS with transparency, they may have substantial discretion and valuation rules which made them provide financial results which were less informative.

In conclusion, the IFRS transition has presented quite notable impact on European accounting rules and practices, that relies de facto on the nature of European Union tax system and some discrepancies with some IFRS fields that relates to employee benefits, segment reporting, and capital allocation, fair valuations, leasing and deferred taxation. Firm’s conversion to IFRS made a deep improvement of the European Union accounting system and this enabled them implement a model of financial reporting that would facilitate firms to participate in an international marketplace.