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EFFECT OF INTERNATIONAL FINANCIAL REPORTING STANDARDS ADOPTION ON EARNINGS QUALITY OF LISTED CONGLOMERATE FIRMS IN NIGERIA
1.1 Background to the Study
Globalization of the world's capital markets has brought to the forefront the increasing need for comparable and reliable financial information to support the varied transactions and operations of these markets. Transparency and relevance are attributes of financial reporting. Accounting information that meets these attributes increases investors‟ confidence, leading to enhanced capital flow. The recent financial crisis has been partly blamed on the erosion of investors‟ confidence, owing to perceived lack of transparency in financial markets. Devalle, Onali, and Magarini (2010) posit that opaque markets aggravate the problem of information asymmetry between insiders and outsiders, which could impede the efficient allocation of resources. The International Accounting Standards Board‟s (IASB) has equally acknowledged the need to improve reporting quality globally. Consequently, the IASB promotes the application of a common set of financial reporting standards as a solution.
Further, extant literature suggests that applying diverse accounting standards around the world often results in the use of different criteria for resources accounting (IASB, 2009; Lorchir, 2015). Analysts view that this creates inconsistencies in the investment information employed by global investors; a gap that is expected to be narrowed by global application of IFRS. In this regard, complying with IFRS is expected to facilitate informed trading and reduce adverse selection in the market. Information asymmetry puts small investors, who are less likely than their sophisticated counterparts to generate financial information from alternative sources at a disadvantage in the market (Ball, 2006). The notion behind the promotion of a common set of high-quality standards globally is that the risk and cost of processing financial information to investors is reduced.Hassan (2015) opined that in Nigeria, the information disclosure
requirements in the financial statements under Nigerian generally accepted accounting principles (NGAAP) were grossly inadequate to effectively bridge the information asymmetry between companies and the users of the financial statements. Shehu (2011) posit that financial information quality in Nigeria remains weak compared too many advanced jurisdictions. This resulted in the hampering of the growth of efficient equity markets. A common complaint among investors in Nigeria is that financial information on company performance is either unavailable or, if provided, lacks reliability. Hence, he conceived that companies will disclose more of their financial information with the transition to IFRS.
The adoption of IFRS definitely affects many aspects of accounting. For instance, the introduction of fair value principle, which is regarded as the most important implication of IFRS, motivates more debate on the adoption of the standards. More clearly, IFRS required the use of fair value contrary to the book value as used by Nigerian GAAP. It is believed that fair value provides up-to-date information about assets as it reflects their real value. However, impairment test is carried out on goodwill under IFRS, while it expected to be amortized under NGAAP. Adeyemi (2016) is of the opinion that managers have more flexibility under IFRS and may intend to use their accounting decisions to manipulate impairment test of goodwill which could affect the quality of reported earnings. Likewise, NGAAP allows convertible debt to be recorded as long-term debt, while the IFRS records convertible bonds separately into the equity component and the debt components. IFRS which is a principle-based accounting method give managers significant flexibility and discretion and leave more room for earnings manipulation than rule-based accounting standards NGAAP (Adeyemi, 2016).
Furthermore, Delloite (2013) reported that the inception of IFRS has led to the use of a variety of definitions for elements of financial statements like assets, liabilities, equity, income and
expenses. It has also resulted in the use of different criteria for the recognition and measurement of items in the financial statements. In addition, Galaen and Stenheim (2010) recognised that the shift to IFRS represents substantial change in recognition and measurement of accounting numbers and it is reasonable to believe that adoption of IFRS will affect the quality of accounting numbers. Application of the IFRS is expected to produce higher quality financial information because the International standards are characterised by features that facilitate reporting of quality accounting information (Barth et al, 2008).
Earning quality is defined in SFAC No.1 (2008) as earning of higher quality that provides more information about the feature of a firm‟s financial performance that is relevant to a specific decision made by a specific decision maker. The quality of accounting information is often determined by the quality of the reported earnings (Schipper, 2003). Researchers use different methods in determining the quality of reported earnings, and so, there is no universal approach on how to determine quality of the reported earnings.Schipper and Vincent (2003) consider three earnings quality constructs: persistence, predictive ability, and the time-series variance of earnings as measures of earnings quality. These constructs are consistent with the Conceptual Framework which suggests that earnings quality might be assessed by some combination of persistence, predictive ability, and variability of earnings.
Earnings being one of the most significant economic variables in financial statements serve as a decision base for different users of financial information. The IASB‟s campaign on the global adoption of IFRS has recorded considerable achievements and over 120 countries have adopted or officially allowed IFRS (PWC, 2014). Other countries are establishing timelines to adopt the IFRS. However, the perception that adoption of IFRS is likely to increase quality in reporting earnings and usefulness of financial statements globally has generated considerable
debate. Studies (Lorchir, 2015; Barth, & Schipper, 2008; Atwood, Drake,Myers,& Myers,2011; Agostino, Drago, & Silipo,2011) have analysed the impact of IFRS adoption on earnings quality. Different perspectives are followed, targeting various countries and continents.
There are two conflicting views regarding the influence of IFRS adoption on accounting quality. Some studies show that IFRS implementation improves earnings‟ quality. In particular, proponents such as Agostino et al, (2011); Lorchir (2015) argued that firms reporting under IFRS provide more decision-useful accounting numbers, for investment and lending purposes relative to firms reporting under domestic accounting standards. The decision usefulness of IFRS-compliant accounting numbers from a theoretical standpoint has also been established. Furthermore, others such as Carmone and Trombetta (2008) andBarth and Schipper(2008) argued that the principles‟ orientation underpinning the conceptual framework of IFRS is likely to discourage fraud.
Conversely, opponents of global application of IFRS question the notion that uniformity of standards has significant impact on earnings quality, given that preparers‟ incentives remain predominantly divergent and largely out of IASB‟s control (Ball et al, 2003). Others (Van der Meulen et al. 2007; Taylor, 2009; Soderstrom & Sun, 2007; JeanJean & Stolowy, 2008) provide empirical evidence to show that IFRS accounting numbers are not of higher quality than Domestic accounting standards in relation to improving earnings quality (Ahmed, Neel, & Wang, 2013). They hold the general view, that propagating an agenda for the adoption of IFRS globally in order to improve earnings quality may be misleading. Additional explanations for the inability of IFRS to improve earnings quality are built on the diversification of country-specific institutional factors which potentially affect enforcement of IFRS even if they were of higher quality. Under this line of argument, relevant research observes that the IASB would be unable
to influence institutional factors that strongly affect operational outcomes of firms within jurisdictions (Hung &Subramanyam,2007). The World Bank‟s (2015) review of government policies and institutions in Africa shows that half of the region‟s countries posted relatively weak governance quality. The fact that Nigeria is adopting IFRS under relatively weak governance quality makes Nigerian conglomerate firms a useful setting to test the effect of IFRS on earnings quality in such jurisdictions.
Conglomerate firms in Nigeria are involved in nearly every sector of the economy as well as every chain of production. For the Six listed conglomerates, their interests span the whole spectrum of the economy from manufacturing to automobile, real estate, hotel, general trade and merchandise, power, agriculture and services, among other sectors. Either within a conglomerate or the large sectorial group, an investor will find any sector he wishes to invest in; they all have nothing less than eight business lines that run through the entire sector of the economy (Taofik Salako, 2013).
The general consensus in prior research is that accounting earnings are a premier source of firm-specific information, which shows that investors rely on earnings more than on any other summary measure of performance. Given that conglomerate firms engage in series of unrelated business activities make them to be prone to financial and business risk which continues to erode their earnings. Thus, earnings quality of conglomerate firms becomes paramount because of its continued improved contribution to economic growth. It has also been found that Nigeria has enormous prospects for investment and growth with rich deposits of natural and human resources, which will potentially attract the interest of international investors, particularly at this era of “Change and diversification”, economic recovery and growth plan faced by the country
Expectedly, financial reporting quality of Nigerian firms has become an issue of interest to the international investing community.
1.2 Statement of the Problem
Earnings could be used to tell the truth and in cheating or misleading. The difference between true earnings and reported earnings impacts on earnings quality, which is described by the capital markets as a summary indicator of financial reporting quality (Francis, Olsson & Schipper 2008). Corporate scandals like Enron, WorldCom, Parmalat and, more specifically, Afribank Nigeria PLC, Cadbury Nigeria PLC and other corporate fraud in Nigeria have continued to raise questions about earnings quality in Nigeria and the world at large.
As the debate on the impact of global IFRS adoption continues, little is known about the outcome in Nigeria despite IFRS adoption, creating a gap. Studies (See Ashbaugh & Pincus, 2001;Ball et al. 2003; Leuz et al. 2003; Tendeloo & Vanstraelen, 2005;Daske, 2006; Bartov, 2005; Ball, 2006; Callao et al. 2007; Hung & Subramanyam, 2007; Van der Meulen et al. 2007; Soderstrom & Sun, 2007; JeanJean & Stolowy, 2008; Barth et al. 2008;Chen et al. 2010; Devalle et al, 2010;Agostino et al, 2011; Christensen et al. 2015;) have continued to submit empirical evidence supporting and refuting the capability of IFRS to enhance earnings quality. However, until date, a consensus is yet to be reached on the efficacy of mandatory IFRS adoption impact on earnings quality in developing countries. This realisation suggests that the debate remains unsettled, and there is a need for further empirical evidence on different jurisdictions to enrich the debate (Bruggemann et al. 2013). Specifically, current studies have not looked at Africa closely in this area of accounting research, even as African countries have adopted the IFRS and set timelines for mandatory adoption (PWC, 2014).
This study is apt given that most of the studies mentioned above were carried out in developed countries and to the best of our knowledge there exist scanty empirical works carried out on IFRS adoption and Quality of accounting information in Nigeria. Very few studies in this area in Africa include the study of Elbannan (2010) from Egypt,Outa (2011) from Kenya, Ames (2013),Yeboah and Yeboah (2015)both from South Africa and Lorchir (2015) from Nigeria. Other Nigerianstudies have focused mainly on value relevance attributes of earnings quality and banking sector as domain (See for example, Tanko, 2012; Akindele, 2012; Akpaka, 2014; Sanni et al 2014; Madawaki 2014; Adaramola & Oyerinde, 2014; Abdul-Bakki et al., 2014; Adebimpe
& Ekwere, 2015; Yahaya et al., 2015; Abata, 2015;Hassan, 2015; Umoren & Enang, 2015; Adereti & Sanni, 2016;Ogenjuwa, 2016; Olugbenga, 2016; Nnadi& Nwobu, 2016; Agir, 2017;Uwuibge et al, 2017;) ignoring other metrics of accounting quality and other sector.
The only study that covered several earnings quality measures is the study by Lorchir
(2015) focusing exclusively on eight countries in Africa.The study also incorporate 53 firmsin Nigeria to test the impact of mandatory IFRS adoption on earnings quality. However, the findings could not be relied upon in this domain, given that Nigeria adopted IFRS in 2012 and the study only covers 2000-2012, unlike South Africa, Kenya and Egypt that adopted IFRS between 1997 and 2005.
Accounting studies worldwide in line with signaling and prospect theories preposition,have found the variable earnings management towards small positive target (SPEAR) very important measure of earnings quality, because managers intend to signal higher quality accounting and investor react negatively to small losses therefore managers act to avoid negative reaction from investors by manipulating earnings upwards to avoid small losses and maintain
investors‟ confidence. However, to the best of our knowledge; no empirical studies on earnings quality and IFRS in Nigeria used this earnings management measure.
Therefore, from the foregoing, it can be acknowledged that while studies have focused on examining IFRS adoption and the implications on earnings quality in other countries, little is known in Nigeria. This research gap exists even though Nigeria has already mandatorily adopted the IFRS.
1.3 Research Questions
The study is guided by the following questions:
- How does IFRS adoption affectearnings persistence in the listed conglomerate firms in Nigeria?
- What is the effect of IFRS adoptionon earnings predictabilityof listed conglomerate firms in Nigeria?
- To what extent does IFRS adoption affect earnings management towards small profits of listed conglomerate firms in Nigeria?
1.4 Objectives of the Study
The broad objective of this study is to determine whether IFRS adoption leads to higher quality accounting numbers following the switch from NGAAP to IFRS regulation in Nigeria conglomerates firms. Thespecific objectives are to:
Examine the effect of IFRS adoption on earnings persistence in the listed conglomerate firms in Nigeria
- Investigate the effect of IFRS adoption on earnings predictability of listed conglomerate firms in Nigeria.
- Assess the effect of IFRS adoption on earnings management towards small profits of listed conglomerate firms in Nigeria.
1.5 Statement of Research Hypotheses
In line with the objectives, the following null hypotheses were formulated and tested:
H01: IFRS adoption has no significant effect on earnings persistence of listed conglomerate
firms in Nigeria.
H02: IFRS adoption has no significant effect on earnings predictability of listedconglomerates firms in Nigeria.
H03: IFRS adoption has no significant effect on earnings managements towards small profits of listed conglomerate firms in Nigeria.
1.6 Scope of the Study
The study focused on all conglomerate firms listed on the Nigerian Stock Exchange (NSE) as at 31st December, 2015. The research seeks to determine whether adoption of IFRS has a significant effect on the quality of earnings of Conglomerates firms in Nigerian by examining differences in earnings quality between mandatory IFRS and NGAAP reporting years. The research coveredTen (10) years period from 2006-2015 (2006-2011 pre IFRS and 2011-2015 IFRS regulation). This has been a period where several economic policies and regulationswere made in Nigeria. It is also within this period that the world experienced another fold of global economic crisis and recession which exact significantpressureon the earnings of ma
conglomerate firms in Nigeria. The independent variable for the study is IFRS Adoption while the dependent variable is Earnings Quality represented by Earnings Persistence, Earnings Predictability (Cash flows Predictability)and Earnings Management toward small profits (SPEAR).