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IFRS Might Produce Better Earnings, Study Predicts

Tammy Whitehouse | February 3, 2012

It's tough to predict how financial reporting, particularly earnings quality, would change in the United States if the Securities and Exchange Commission were to adopt international accounting rules, but a recent academic study makes an attempt – and reaches a conclusion that surprises even the authors.

Three accounting professors at the University of Windsor and the University of Auckland examined the impact of adoption of International Financial Reporting Standards on earnings quality among companies located in IFRS-reporting countries with listings in U.S. capital markets. The study looked at indicators of earnings quality to see how they might be affected by an adoption of IFRS. The American Accounting Association published the article, titled How Would the Mandatory Adoption of IFRS Affect the Earnings Quality of U.S. Firms? Evidence from Cross-Listed Firms in the U.S. and authored by Jerry Sun, Steven Cahan, and David Emmanuel.

The professors chose the IFRS-adopting companies to serve as surrogates for U.S. companies because they transitioned to IFRS under a mandatory adoption at some point during the sample period, and earlier research has shown that earnings for cross-listed companies are influenced by U.S. Generally Accepted Accounting Principles, even if those companies follow a different domestic accounting standard. They matched those companies to U.S. companies using sophisticated data analysis to separate the effect of IFRS adoption from other events that might affect reporting.

The study looked at five indicators of earnings quality, including discretionary accruals, target beating, earnings persistence, timely loss recognition, and the earnings response coefficient. For three of those indicators, the authors found no difference in earnings quality before and after the adoption of IFRS. But for two indicators, incidence of small positive earnings and earnings persistence, the study found compelling, consistent evidence that earnings quality improved after adopting IFRS. “Our results indicate that IFRS could improve earnings quality if U.S. firms adopted IFRS by reducing target beating and increasing earnings persistence,” the authors wrote. “These results are slightly surprising, since the U.S. is thought to have high-quality standards that leave little room for improvement.”

The SEC was expected to decide in 2011 whether, when and how the United States would transition to IFRS, but has delayed the decision at least a few months into 2012. The authors expect the results of their work to be of interest to the SEC, even as they acknowledge limitations. “We have not attempted to quantify the benefits of improved earnings quality,” they wrote. “We have not considered any possible benefits for U.S. firms associated with convergence, (and) we have not considered the cost of adopting IFRS for U.S. firms.”