The Effect of Mandatory IFRS Adoption on Conditional Conservatism in Europe

Abstract

We study the effect of mandatory adoption of International Financial Reporting Standards (IFRS) in Europe in 2005 on conditional conservatism. We capture conditional conservatism with a modified version of the Khan and Watts measure (C_Score) that also controls for potential shifts in unconditional conservatism and cost of capital. From a sample of 13,711 firm‐year observations drawn from 16 European countries spanning the 2000–2010 period, we document an overall decline in the degree of conditional conservatism after the adoption of IFRS. We show that the decline in conditional conservatism is less pronounced for countries with high quality audit environments and strong enforcement of compliance with accounting standards using the Brown et al. audit and enforcement index. As asset impairment tests are a key mechanism ensuring conditional conservatism in the IFRS framework, we further examine these. We show that firms booking an asset impairment present a smaller decline in the degree of conditional conservatism relative to firms that do not. We also demonstrate that firms that do not book an asset impairment when evidence suggests the probable need to do so experience a more pronounced reduction in conditional conservatism. We argue that IFRS are conceptually conditionally conservative but that inappropriate application of conditional conservatism principles is likely to prevent financial reporting from reaching the level of conservatism targeted by the International Accounting Standards Board (IASB).

How institutional factors and IFRS affect the value relevance of conservative and non-conservative banks

“…According to them, this finding lies to the IFRS restricting of loan-loss provisioning by allowing only incurred losses, thus limiting banks' ability to timely recognise losses. The above deterioration in timely recognition of losses in the post-IFRS era is also verified by other non-banking related studies (Andre et al, 2014;Ahmed et al, 2013a;Chen et al, 2010). ii While the separate investigation of value relevance and conservatism has attracted much of the academic interest, their joint effects have been partly ignored.…”

“…Nevertheless, the Andre et al (2014), conservatism has dropped following mandatory IFRS adoption, but this drop is less pronounced in strong institutional environments compared to weak ones.…”

The implications of research on accounting conservatism for accounting standard setting

“…Andre et al (2015) study the effects of IFRS implementation in Europe on conditional conservatism. Overall, they report a decrease in the level of conditional conservatism following IFRS adoption.…”

Accounting for business combinations: Do purchase price allocations matter?

“…To test H3 we estimate the following models adapted from (Hayn and Hughes, 2006): PrðDIMP i;½tþ1;tþ2 or DIMP i;½tþ1;tþ2;tþ3 Þ ¼ a 0 þ a 1 ExpGW i;t þ a 2 AbGW i;t þ a 3 Bad News i½tþ1;tþ2 þ a 4 Bad News i½tþ1;tþ2 Ã ExpGW i;t þ a 5 Bad News i½tþ1;tþ2 Ã AbGW i;t þ a 6 ACQ DSALE i;½tþ1;tþ2 þ a 7 ACQ ROA i;½tþ1;tþ2 þ a 8 ACQ DROA i;½tþ1;tþ2 þ a 9 ACQ BS GDWL i;t þ a 10 ACQ MTB i;½tþ1;tþ2 þ a 11 ACQ SIZE i;½tþ1;tþ2 þ a 12 ACQ LEV i;½tþ1;tþ2 þ Acquirer industry dummies þ e i ð4Þ IMPpct i;½tþ1;tþ2;tþ3 Þ ¼ a 0 þ a 1 ExpGW i;t þ a 2 AbGW i;t þ a 3 Bad News i½tþ1;tþ2;tþ3 þ a 4 Bad News i½tþ1;tþ2;tþ3 Ã ExpGW i;t þ a 5 Bad News i½tþ1;tþ2;tþ3 Ã AbGW i;t þ a 6 ACQ DSALE i;½tþ1;tþ2;tþ3 þ a 7 ACQ ROA i;½tþ1;tþ2;tþ3 þ a 8 ACQ DROA i;½tþ1;tþ2;tþ3 þ a 9 ACQ BS GDWL i;t þ a 10 ACQ MTB i;½tþ1;tþ2;tþ3 þ a 11 ACQ SIZE i;½tþ1;tþ2;tþ3 þ a 12 ACQ LEV i;½tþ1;tþ2;tþ3 þ Acquirer industry dummies þ e i The other variables are as defined earlier. Impairment testing is an accounting mechanism intended to ensure timely loss recognition (André et al, 2015;Kim et al, 2013;Roychowdhury and Martin, 2013), i.e., so that bad news (or losses) regarding earnings is reflected more promptly than good news (or gains) (Basu, 1997). We therefore examine how the level of Abnormal Goodwill affects the probability of booking future goodwill impairment when news is bad.…”