Adoption Of International Financial Reporting Standards And Earnings Management In Quoted Manufacturing Companies In Nigeria
This study examined the impact of the adoption of the International Financial Reporting Standards (IFRS) on earnings management in quoted manufacturing companies in Nigeria. Published Financial statements prepared under the Nigerian Statements of Accounting Standards (SAS) and the restated financial statements using IFRS guidelines for 20 quoted companies were used for the study. Discretionary accruals were employed as earnings management variable, while, leverage, cash flow, growth, return on assets (ROA), size and loss were performance proxies. The t -test statistic was used to test the impact of the adoption of IFRS on earnings management, while, multiple regression was conducted to examine the relationship between earnings management and performance. Multi-collinearity tests conducted revealed that the correlation among the variables were not strong enough to distort the result of the multiple regression. The results showed that the decrease in earnings management after the adoption of the IFRS was not statistically significant. The results also revealed that the relationship between earnings management and financial performance of manufacturing companies in Nigeria is significant before and after the adoption of the IFRS. The study unveiled the fact that accounting standards on their own do not improve quality of financial reports. It was recommended that there should be increased education of managers on IFRS guidelines and adoption.
Keywords: IFRS, Earnings management, Discretionary Accruals, Performance
1.1 Background of the Study
The picture of how well a firm has performed can be derived from the evaluation of information contained in accounting reports of the firm. Managers, therefore, owe it a duty to the various stakeholders especially, investors to prepare accounting reports that express the true and fair view of the business transactions for the period specified. According to the BPP Learning Media (2012), financial reports represent economic phenomena in words and numbers that must faithfully represent relevant phenomena that it purports to represent.
Sometimes, however, when businesses are doing badly managers are tempted to use accounting techniques to enhance the apparent performance of the firm in an unjustified way (Jones & Jones 2011). Managers exploit flexibility in accounting rules which allows them to determine the direction of accounting reports by adopting accounting policies that serve the interest of management. This is one of the reasons why different accounting information can be generated from the same business data when the accounting numbers are manipulated.
The manipulation of accounting information to achieve a desired purpose is earnings management.
Jawad and Xia (2015) described earnings management as a form of creative accounting. Earnings management involves taking deceptive steps to present financial statements that suits or protects management interests. According to Akhgar (2012), earnings management is the practice of using tricks to misrepresent or reduce transparency of the financial reports. Assessment of a firm’s financial performance will be distorted when accounting information
contained in the accounting reports is not a true reflection of the business transactions it purports to represent when firms engage in earnings management.
In order to ensure high quality accounting information that will eliminate or reduce significantly earnings management, accounting standards are introduced by regulatory bodies of accounting practices. Accounting standards are the authoritative statements of best accounting practices relating to various aspects of measurements, treatments and disclosures of accounting transactions (Shil, Das &Pramanik, 2009). Biddle and Hilary (2006) as cited in McNichols and Stubben (2008) found that better accounting information reduces information asymmetry between managers and outside suppliers of capital. Information asymmetry occurs when a party to a contract has information advantage over the other party thereby resulting in imbalance in information. Imbalance in information allows managers to manipulate accounting numbers in order to sustain or enhance the market value of the company.International Accounting Standards Board (IASB) introduced International Financial Reporting Standards (IFRS) to reduce information asymmetry on financial reports prepared in different countries.
Nigeria adopted IFRS for quoted companies in the year 2012 to replace the Nigerian Statements of Accounting Standards (SAS). Okafor and Ogiedu (2011) found evidence that IFRS have the potential for yielding greater benefits such as better information for equity holders and regulators, enhanced comparability and improved transparency of results, improve business performance management and impact on other business functions apart from financial reporting. It is in the light of the Okafor and Ogiedu (2011) findings that this study examines the impact of IFRS on earnings management in the manufacturing companies in Nigeria.
1.2 Statement of the Problem
The introduction of IFRS is to improve the quality of financial reporting by providing greater disclosure, thus, improving accountability and transparency. According to Barth, Landsman and Lang (2008) as cited in Santos and Cavalcante (2014), the concepts and the recognition, measurement and disclosure criteria established by the IFRS provide higher information quality, which in turn affects the usefulness of the accounting information generated. High quality accounting information will ensure that earnings management is eliminated or reduced significantly. Although, Onalo, Lizan and Kaseri (2015) examined the effects of changes in accounting standards on earnings management in Malaysia and Nigeria, the study, however, focused mainly on the banking industry. The banking industry is highly regulated such that the results may not be applicable to other industries that are not so regulated.
In addition, findings by previous researchers on the impact of IFRS on earnings management is contradictory, thereby making study on the subject inconclusive. While Jeno (2011) reported that earnings management reduced after the post-adoption period in Hungary, Xu (2014) found evidence that IFRS adoption did not reduce the level of earnings management but that earnings manipulation is intensified after the adoption of new accounting standards among United Kingdom private firms.
To the best of the knowledge of this researcher, it is yet to be confirmed through any empirical study that the adoption of the IFRS has eliminated or reduced significantly earnings management in the manufacturing sector of the Nigerian economy and the impacts on financial performance. This study is, therefore, an attempt to fill the existing gap by examining the impact of the IFRS on earnings management in quoted manufacturing companies in Nigeria.
1.3 Objectives of the Study
The main objective of this study is to investigate the impact of IFRS adoption on earnings management in quoted manufacturing companies in Nigeria. Specifically, the study is aimed at achieving the following; to:
- Determine the difference in earnings management between pre and post adoption period of the IFRS in quoted manufacturing companies in Nigeria.
- Examine the relationship between earnings management and performance of quoted manufacturing companies in Nigeria before and after the adoption of IFRS.
1.4 Research Questions
The following questions were raised for this study based on the operationalized variables developed in the conceptual model:
- What is the difference in earnings management between pre and post adoption period of the IFRS in quoted manufacturing companies in Nigeria?
- What is the relationship between earnings management and financial performance of quoted manufacturing companies in Nigeria before the adoption of IFRS?
- To what extent does financial performance affect earnings management in quoted manufacturing companies in Nigeria after the adoption of IFRS?
The following null hypotheses were formulated for the study:
H01: There is no significant difference in earnings management between pre and post adoption period of the IFRS in quoted manufacturing companies in Nigeria
H02: There is no significant relationship between earnings management and financial performance of quoted manufacturing companies in Nigeria before the adoption of IFRS.
H03: There is no significant relationship between earnings management and financial performance of quoted manufacturing companies in Nigeria after the adoption of IFRS.
1.6 Scope of the Study
This study examines the effect of IFRS adoption on earnings management in quoted manufacturing companies in Nigeria taking evidence from those that have operational offices in Rivers State. Published financial statements prepared under the Nigerian statements of accounting standards (SAS) and the restated financial statements using IFRS guidelines were used for the analysis. This is to allow for effective comparisons of the results from the same activities.
1.7 Significance of the Study
This study will be relevant to researchers in identifying the reasons why quoted manufacturing companies in Nigeria engage in earnings management. Regulatory authorities of financial reporting and investors in Nigeria may find it useful in appreciating the extent to which IFRS has helped in eliminating earnings management practices and the justification for its adoption in terms of volume of work and associated cost of adoption in Nigeria. The study will also fill a relevant gap in the literature on earnings management.
Discussion, Conclusion and Recommendation
The overall results of hypotheses testing suggest that IFRS adoption has not improved accounting quality of listed cement and breweries companies in Nigeria.
The investigation showed that:
- The degree of earnings management has not declined in the post-IFRS period.
- Earnings and book values are less value relevant in the post-IFRS period compared to the pre-IFRS period.
- Timely loss recognition is insignificantly larger in the post-IFRS period compared to the pre-IFRS period.
The results of this analysis are reported in Table 4.1-7. While George (2008) found a decrease in earnings management in the United Kingdom post IFRS adoption, Zhou et al. (2009) found a decrease in earnings management in Chinese firms and Morais and Curto (2008) found a decrease in earnings management in Portuguese firms, though Elbannan did not find the same thing in Egyptian firms. He attributes his findings to the lack of enforcement by regulators and a lack of training for those preparing and auditing the financial statements. The same issues may be at play in this fellow African country. Given the positive impact of IFRS adoption on other economies, these results suggest that more careful implementation and enforcement of IFRS standards may be required in Nigeria, and perhaps other countries with similar enforcement characteristics. Numerous studies indicate that accounting quality is not determined by accounting standards alone. Accounting quality is also partly determined by the incentive firms have to provide high-quality financial statements. There is evidence that firms’ dependence on external capital increases their incentives to report higher-quality accounting information and to provide more useful financial disclosures (e.g. Francis et al. 2005). Empirical evidence from studies of individual countries also suggests that improvements in financial reporting quality under IFRS occur mainly among firms with greater financial reporting incentives (e.g. Christensen et al., 2008).
In the case of Nigeria, several institutional factors can influence firms’ reporting incentives in relation to the demand for external capital. First, the Nigerian economy is to some extent driven by the manufacturing sector. Firms in this industry are associated with higher growth opportunities and greater competition for external capital than their counterparts in other industries. Thus, if IFRS enables firms to improve financial reporting to entice external investors, this effect would be expected to be greater in the manufacturing sector.. These expected benefits are based on the premise that mandating the use of IFRS increases transparency and improves the quality of financial reporting. However, there is evidence that accounting standards play only a limited role in determining observed reporting quality. The application of accounting standards involves considerable judgment and the use of private information, and as a result, IFRS (like any other set of accounting standards) provide managers with substantial discretion. How far this discretion is used depends on firm-specific characteristics (reporting incentives and operating characteristics) (Burgstahler et al., 2006), and national legal institutions (e.g., Ball et al., 2000, 2003). Table 4.2 reports the results for the significance tests on the differences of the amount of mean discretionary accruals between the pre- and post-IFRS period.
The results for the t-tests, both assuming equal and unequal variances, show that there is no decrease in discretionary accruals and is highly insignificant with p-values being more than 1% for all occurrences. These findings provide convincing evidence that earnings management has not declined after IFRS was adopted. It could however be that either the pre-IFRS observations are so much influenced by other factors not mentioned that they result in a bias in the findings or the post-IFRS period is too small to show any expected results. Data analysis also indicates that in the post-IFRS period there is almost no difference in value relevance. This could be evidence of an undervaluation of manufacturing firms in the post-IFRS period. The explanation for this is that, ceteris paribus, the market value of firms are to a bigger extent based on intangible assets (e.g. Aboody and Lev, 1998; Kallapur and Kwan, 2004). The recognition principles for intangibles are nevertheless much stricter than for tangible assets within the IFRS. Thus, it would be logical that there is a smaller association between book values and market values.
Table 4.1 represents the first test of Ho1, that IFRS adoption will decrease subsequent earnings management. A significant drop-off in reported earnings post-IFRS adoption would be consistent with a decrease in earnings management as aggressive, earnings-enhancing reporting practices are eliminated or reduced. The results of this test indicate that there is no significant difference in the change in reported earnings post IFRS adoption, but the direction is positive as opposed to the negative coefficient anticipated (p-value <.05). This finding is different from expectation based on Ho1 as previously discussed. A brief discussion of possible factors that could contribute to this finding seems appropriate. These results could potentially be attributable to macroeconomic factors. It may certainly be the case that the post-adoption period in Nigeria yielded better results, on average, across the economy.
This is an especially intuitive explanation given the status of Nigeria as a rapidly developing country and economy. Taken together, it seems unlikely that macroeconomic factors are driving this increase in reported earnings post-IFRS adoption. It may also be the case that IFRS is, in fact, less conservative with respect to revenue recognition. Street et al. (1999) study 221 companies claiming to comply with International Accounting Standards (IASs) in 1996. Their findings reveal significant non-compliance with a long list of IASs including “use of LCM for inventories; violation of the all-inclusive requirement for reporting profit/loss and of the strict definition of extraordinary items; failure to capitalize certain development costs; failure to provide all required disclosures for property, plant, and equipment, particularly those associated with revaluations; failure to comply with pension disclosure requirements;for companies operating in hyperinflationary economies, failure to restate foreign entities in accordance with IAS 29; and charging goodwill to reserves or amortizing goodwill over a period in excess of the 20 year limit” (Street et al. 1999). Based on these findings, it seems unlikely that an overabundance of conservatism is behind the increase in reported earnings. In a related note, it may be the case that auditors are more lenient under the new standards, either because their perceived risk is lower, or because auditing the new standards represents implementation problems. Finally, it may be the case that a monetary change or hyperinflation may have caused these differences. Indeed, as reported by Leuz et al. (2003), inflation in Nigeria between 1990 and 1998 (in the pre IFRS adoption period) averaged 10.41% annually. This is roughly consistent with other developing nations such as India, Indonesia and Pakistan. In fact, the stated goal of regulators in the post adoption period was 3 to 6% inflation annually, according to Selassie (2011). It thus seems likely that inflation is a culprit in the surprising results found in table 4.2. Nevertheless, Leuz et al. (2003) do not consider the inflation rates of Nigeria to qualify as hyperinflation, and keep Nigeria data in their tests. Regardless of the cause, these results do not support Ho1. By this measure, the quality of accounting numbers reported in Nigeria remained relatively unchanged before and after IFRS adoption. This is also inconsistent with expectations as described in Ho1. The second measure of accounting quality—value relevance is tested in Table 4.5 Ho2 it showed that earnings and book values are less value relevant in the post-IFRS period compared to the pre-IFRS period while alternative Hypothesis says that post-IFRS adoption, an increase in value relevance should be observed as investors pay more attention to reported values. The dependent variable is the trading price of the firm in period t relative to the reported financial statement items.
5.2 Implication for Research and Practice
The results of this research confirm that the adoption of IFRS does not automatically translate to higher quality accounting. The findings of this research have implication for our understanding of earnings management, value relevance of accounting numbers and timely loss recognition aspect of accounting quality as well as for researcher estimating discretionary accruals, earnings management and earnings quality. It can also be used as evidence to support theory in extrinsic share valuation or financial analysis.
The research goal was to examine whether the quality of accounting (or financial reporting) has increased in Nigeria after the adoption of IFRS in 2012. The researcher’s results suggest that there has been no increase in financial reporting quality over the first two years after the adoption. This study compares the characteristics of accounting amounts using a sample of quoted manufacturing companies reporting under NGAAP during 2009-2011, and IFRS during 2012-2013. Specifically, the researcher investigated whether there is a change in accounting quality during these two time periods. Following prior research, the research uses accounting quality with earnings management, value relevance, and timely loss recognition metrics. Contrary to our expectations, the research results suggest a decrease in accounting quality over the last years. The research shows that earnings and book value of equity are becoming less value relevant during the IFRS period compared to the pre-IFRS period. The findings on earnings management and timely loss recognition corroborate largely our findings with respect to the value relevance of accounting information. The researcher’s results consistently indicate that accounting quality has declined in the first two years. Interestingly enough, the results from this analysis provides stronger evidence that the quality of financial reporting has decreased in Nigeria after the adoption of IFRS. It is of course dangerous to draw conclusions about the quality of financial reporting using this kind of measures. However, as a group they do offer some evidence of the in formativeness of financial reporting and could be a first indication that the adoption of IFRS may have been overwhelming to many Nigeria companies and has not resulted in a more efficient capital market. Although, further research needs to be done overtime and in other sectors in order to corroborate the results of this study using more and more representative data. In summary, it may be that the decrease in accounting quality is mainly driven by institutional factors (such as cost of initial implementation) and not the new adopted standards.
5.4 Future Research
Findings from this study have provided valuable insights that are of interest to practitioners, scholars, investors and policy makers. Certain issues arising from the firms provide avenues for further research agenda as follows: The study considered the influence of IFRS adoption on accounting quality of quoted manufacturing companies. Future research might incorporate the impact of legal tradition on reported accounting quality in a pre- and post-IFRS adoption setting. Furthermore, researchers might study the incidence of earnings management and value relevance of reported values pre- and post -IFRS adoption in a setting in which the previous standards were consistent with GAAP as opposed to IFRS. Further research can extend this study by replicating the methodology to investigate data of companies in the financial sector and other industries.
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