Measuring the “Adoption” of International Financial Reporting Standards (IFRSs)

In my last  blog entry, I referred to the chameleon nature of the description of IFRS adoption in many countries. I described the contradictions that the International Accounting Standards Board (IASB) presents when it refers to the overwhelming acceptance of the International Financial Reporting Standards (IFRS) globally. This contradiction and confusion generates ambiguity in the application of the standards in most less developed countries that seem to apply the standards from different angles than anticipated by the IASB. This in turn has the potential to undermine the achievement of the benefits of these standards as presented by proponents of IFRSs. 

The question is, how different or similar will the outcomes (results) of IFRSs application(s) be if some countries adopt IFRSs without modifications as compared to those that apply modified versions of the standards? Will the IASB be able to achieve the goal of comparability of financial statements across borders? Will the need to harmonize accounting practices globally in order to achieve uniformity be fulfilled?  The aim of this blog entry is to reassess the claims that countries and the IASB  make when they speak of IFRS adoption, looking for the best way to gauge if and when a country has actually adopted IFRSs.

Let’s start with the basic premise that a single global accounting standard has the prospects of improving information quality across borders and to foster cross border investments. This premise rests on the notion that granted that a single global accounting standard is in place, comparability of financial statements will be achieved, leading to a reduction in information processing costs associated with different national accounting standards, and thereby resulting in a reduction in the overall cost of capital.Should this premise be held constant, we should observe a uniform application of IFRS in every country or company that has the intention of reaping these intended benefits. In reality, that is not the case, as accounting is driven by many factors unique to many countries. These factors may include: cultural differences, legal differences, economic differences, taxation, and many other variables (see Nobes and Parker 2008 for details).

Some of these factors, particularly legislation and taxation, make it increasingly difficult for some countries to wholly commit to the IFRS idea. It then follows that even when countries find IFRS appealing, their approach to IFRS implementation may be different from others either because they are unable to change current legislation to reflect the provisions of IFRSs, or are simply not willing to give up the setting of local accounting rules to a private organization over which they have little control to oversee its operations.

But before proceeding into this debate, its best to revisit the variations in IFRS application globally. According to the work of Nobes and Zeff (2008, 2010) a jurisdiction can “implement” IFRSs through the following ways;

• Adopting the standard setter’s process of setting accounting standards
• Rubber stamping each standard issued by the IASB, so that they become mandatory to apply in that country, thereby replacing national accounting standards with IFRS
• Endorsing IFRSs on a standard by standard basis as issued by the IASB (with possibility of some differences or not endorsing some of the standards)
• Fully converging national standards towards those issued by the IASB
•  Partially converging national standards towards IFRS
•  Merely allowing (permitting ) the use of IASB’s standards

·        This wide variety of ways in which IFRSs can be implemented in a local jurisdiction makes it less clear what the terminology "IFRS Adoption” actually refers to. While the IASB speaks of IFRS adoption, meaning any effort to reflect portions of their standards in a local jurisdiction, that in itself can surely not constitute proper IFRS adoption, can it? To further this line of reasoning, there is every need to understand how global adoption of standards are construed by actors at the international, transnational and local levels.

Local misinterpretation of IFRS adoption

This ambiguity in the definition of what IFRS adoption constitutes has led to misinterpretation of IFRS adoption in less developed countries. In this context, I speak only of IFRS in Africa, as I am only familiar with IFRS implementation in these countries.

For instance, in many parts of Africa, IFRSs adoption occurs when the accountancy profession has made an announcement that they would adopt IFRSs as their substantive accounting standards. This means that, as a profession, they begin to update the accounting education curriculum of professional accountants with IFRSs. Irrespective of whether there are legislative provisions for companies to prepare IFRS in accordance with IFRSs, IFRS adoption thus takes place once the accountancy profession makes the pronouncement.

In other parts of Africa, this global ambiguity is translated into a different interpretation whereby some industry regulators may make announcements of IFRS adoption, independent of the accountancy profession, and require companies in the industry to adopt IFRSs. This then leads to only a handful of companies in a particular industry actually applying the standards – yet the country is registered as an “adopter” by the IASB. A typical example is where the Central Bank with regulatory authority over banking entities, requires companies to adopt IFRSs in their reporting framework. This form of IFRS adoption does not constitute IFRSs adoption.

Another form of IFRS adoption is when there is a legislative provision requiring entities to adopt IFRSs. Although this form of adoption might look similar to mandatory adoption, it still leaves us with the question of who really is responsible for making the pronouncement of a country’s adoption of IFRS? At which point can a country claim to have adopted IFRSs?

What is the best measure of IFRS adoption? And why is it adopted?

To claim adoption of IFRSs it is important to take stock of how adoption of IFRS is measured. What instruments, proxies can be used to gauge the level of IFRS adoption in a country, company or an organization? Is IFRS a law? And if so, what penalties apply for non-compliance?

To answer these questions it is important to look beyond developed countries and into developing countries. There are a number of reasons why developing countries will be interesting to examine. Firstly, accounting researchers have come to the conclusion that developing countries which have no resources to develop their own accounting standards due to the associated cost burden of setting standards tend to adopt those already developed for use by developed nations. Second, developing countries have often been persuaded to adopt internationally recognized best accounting practices by international organizations such as the World Bank, IMF, OECD, DFID, USAID and many other organizations. This is because these countries to a larger extent depend on these organizations for financial and technical assistance. It is therefore important to examine how less developed countries come to embrace and interpret these standards from the global level into the localized economy.

Generally, IFRS adoption is the responsibility of a particular institution. Although these institutions and their manadates may differ from country to country, the pronouncements on the adoption of the standards may look similar. On a broader scale, announcements on IFRS adoption may take the following wording;

Important phrases used in IFRS adoption pronouncements

The country/company has adopted…

i.               IFRS as issued by the International Accounting Standards Board

ii.              IFRS as endorsed by the European Union

iii.            IFRS as adopted by the accounting regulator

iv.            IFRS as permitted by the accounting regulator

This range of terms in itself demonstrates the bandwidth of possibilities within “adoption” of IFRSs

Sources of IFRS adoption Authority

To measure IFRS adoption, it is best to start with asking who has the authority to declare that a country has adopted IFRSs or not. This authority differs from country to country and particularly from continent to continent. In many cases, actors of different regulatory fields become involved in the enforcement of these standards , but this authority to enforce the standards has to be obtained from the legal provisions of the country or nation state.

In many countries in Africa, the different industry regulators such as the securities regulator, insurance regulator and banking regulator have played an important role in arriving at the decision to adopt IFRS. In some countries, some industry regulators may have oversight responsibility to prescribe the accounting standards that should be used by industry players. For instance, the central banks Act of some countries gives the central bank the legal backing to determine which accounting standard to apply in all banking entities. In other countries, there is a separate accounting regulator with the legal mandate to prescribe the accounting standards to apply by all public interest entities.

Accounting regulators often have the authority to make pronouncements on the adoption of IFRS. This authority possessed by the accounting regulator is usually driven from the constitution via the issuance of an act or certain by-laws. To obtain the version of IFRS adopted in a country, it is therefore important to review the pronouncement of the accounting regulator or the institution with the legal authority to make such pronouncement. In this pronouncement, there is also the need to examine the statement of pronouncements by looking at the key words used to ascertain the version of IFRS so adopted in the country.

In many instances, the following words are used when countries talk about IFRS adoption:

Key words in IFRS adoption

i.               IFRS is permitted

ii.              IFRS is permitted for all

iii.            IFRS is required

iv.            IFRS is mandated

v.              IFRS allowed

vi.           IFRS is not prohibited

vii.         IFRS is permitted but not mandatory

viii.        IFRS is required for some, permitted for others

ix.            IFRS is permitted but not often used

x.              IFRS is the only accounting standard in the country

Wide Variations in IFRS Adoption. Source: Author's Own Drawings

Where to find information on IFRS adoption in a Financial Statements

To ascertain whether or not an entity has adopted IFRS, one needs to carefully examine the financial statements of the said entity. This task however has become very tedious as the volumes of financial statements have grown in the recent past following the widespread switch to IFRS. The most obvious sections of the financial statements to look at is the “notes to the financial statements”, where the company usually mentions the basis of preparation i.e, the accounting standards used in preparing the financial statements. This usually states in a more generic fashion that the financial statements have been prepared in accordance with (xyz) accounting standards. In the case of IFRS, it usually states that….. the financial statements have been prepared in accordance with International Financial Reporting Standards.

Apart from the “notes to the financial statements ”, another place to determine if indeed an entity has adopted IFRS is to examine the audit report. Usually, regulation and International Standards on Auditing (ISA) issued by the International Federation of Accountants (IFAC) dictate that the auditors provide details of the accounting standards used in preparing the financial statements and on which basis the audit opinion can be formed. From this section of the financial statement, the auditor will mention that the financial statements have been prepared in accordance with International Financial Reporting Standards on which basis we conducted our audit. These two sections of the financial statements are the only places where one can obtain a reasonable assurance of the version of IFRS which has been used by an entity.

In developing countries the measure of IFRS adoption seems a lot more different from what is perceived in developed countries. This ambiguity at the local level seems to have emanated from the lack of clarity of what adoption represents in the developed countries. For most countries in Africa, adoption is said to have occurred when the institution mandated to ensure IFRS adoption has announced that IFRS is formerly adopted. For other countries, IFRS adoption means that the audit report of adopting entities in the local economy issued by the auditor of the company applying these standards can attest by way of the audit report that the financial statements are in full compliance with IFRS as issued by the IASB. And yet for others, IFRS adoption is said to have occurred only when the law mandates all entities or some industries to comply with IFRS.

These ambiguities on the actual meaning of IFRS adoption are constructed differently in different parts of the world. But more important about this problem is the failure of the IASB to clarify which versions of IFRSs are used by different countries.  Whereas actors at the local level construct their own meaning of IFRS adoption which is then applied to the standards, actors at the transnational and internatial arena aslo construct IFRS adoption differently. This then presents enormous challenges on the ability of financial statements across jurisdictions to be compared. The result of this ambiguity is the reduction in the validit of the claim from the IASB that the application of IFRS will result in the comparability of financial statements from one jurisdiction to the other. It is important for proponents of IFRS recognize that, the lack of uniformity in the adoption patterns of IFRSs themselves posses a great danger to the achievement of the comparability object of a single global accounting standard than the standards themselve. Should countries continue to apply the same standards in different fashions, the result is as good as not having a single global high quality financial reporting standard.