ACCA research report explores benefits of IFRS convergence in China

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19 Apr 2013

The Association of Chartered Certified Accountants (ACCA) has published a report summarising research on the impacts of the convergence with International Financial Reporting Standards (IFRS) in China. The report finds that IFRS convergence in China has been beneficial where companies have had appropriate legal, governance and commercial incentives to provide high-quality disclosures.

The report, Does IFRS Convergence Affect Financial Reporting Quality in China? was prepared on behalf of ACCA by Dr Edward Lee and Professor Martin Walker of Manchester University, together with Dr Colin Zeng from the University of Bristol. The report evaluates the effects of IFRS-converged Chinese Accounting Standards (CAS) by comparing the 'value relevance' of financial statements issued before and after 2007, when IFRS-converged CAS became mandatory.

The report explains the reliance on 'value reference' as follows:

Value-relevance analysis examines the association between the share price of firms and the accounting information they issue, such as book value and earnings. It is inferred here that the higher the association, the more useful the accounting numbers issued by firms are to the valuation decisions of investors, who are an important group of end-users of financial statement information.

Because some entities in China were required to provide IFRS reconciliations prior to 2007, the research report utilises these entities as a control group to attempt to focus on the impacts of adoption of IFRS-converged CAS, rather than other possible causes such as the business cycle or a time trend.

The research concludes there has been a significant increase in the value relevance of reported earnings following mandatory adoption of IFRS-converged CAS. However, the report notes that this effect varies between entities, and puts forwards hypotheses to explain these differences based on various categories of entities, largely based on the demand for external capital.

For example, the research found a stronger effect for manufacturing entities and entities from less developed regions, as these entities tend to have a higher reliance on external capital. In contrast, the effect was seen as less pronounced among listed firms under the control of the Chinese central government, as such firms may be less motivated to improve financial reporting quality due to lesser reliance on external capital, and also in relation to firms which were underperforming or in distress, which may be due to the effects of the adoption of IFRS-converged CAS being masked by earnings management to avoid delisting.

As China is a developing economy, the report's findings are of particular interest. Previous research has consistently indicated that the benefits of mandating or converging with IFRS are concentrated in countries with strong legal enforcement and investor protection, which tend to be less developed in transitional economies than developed ones. By focusing on a number of economic and institutional factors affecting the demand for capital, the report concludes:

  • even among countries with weak legal enforcement and investor protection, IFRS or converged accounting standards can lead to improved financial reporting outcomes as long as they have incentives to communicate with outside investors
  • in countries where state capitalism dominates, IFRS adoption or convergence can benefit the wider economy by reducing the capital acquisition disadvantage of firms that receive less state support.

Click for ACCA press release (link to ACCA website).

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