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i
d
0
d
1
BVEPS
i
d
2
NIPS
i
Error
i
; 6
where:
P share price three months after the scal year-end date;
P* residuals from a regression of P on industry and time (year) xed effects;
BVEPS book value of equity per share; and
NIPS net income per share.
Consistent with other measures, the above regression is run separately for the pre-adoption and the
20
This is in line with Section 319 of the Corporations Act 2001, which requires Australian listed corporations to
lodge their nancial reports within three months after the end of the scal year-end to the Australian Securities
and Investments Commission (ASIC).
132 Chua, Cheong, and Gould
Journal of International Accounting Research
Volume 11, No. 1, 2012
post-adoption periods by using the rm-year observations that have been pooled into the respective
time periods.
The second and third value relevance measures are based upon the explanatory power from a
Basu (1997) reverse return regression of net income per share (NI/P) on annual share price
returns. Consistent with prior research, we run separate regressions for rms with good news
(rms with non-negative annual share returns) and rms with bad news (rms with negative
annual share returns) (Basu 1997; Ball et al. 2000; Barth et al. 2008), while also similarly
controlling for industry and time (year) xed effects as in the previous measure.
Equation (7): Regression of [NI/P]* on RETURN:
NI=P
i
d
0
d
1
RETURN
i
Error
i
; 7
where:
NI/P net income per share divided by the beginning of scal year share price;
[NI/P]* residuals from a regression of NI/P on industry and time (year) xed effects; and
RETURN shareholders total annual return from nine months before the scal year-end to
three months after the scal year-end.
The above regression is run separately for the pre-adoption and the post-adoption periods for both
good news and bad news rms using the rm-year observations that have been pooled into the
respective time periods.
IV. RESULTS
Descriptive Statistics
Table 5 presents the descriptive statistics for both test variables and control variables across the
pre-adoption and the post-adoption periods. A comparison between the periods reveals that the
mean or median values across all continuous test variables are signicantly different, with the
exception of accruals (ACC). This could possibly be explained by the economic downturn
experienced worldwide during the post-adoption period, therefore causing signicant changes to the
test variables. It is interesting to note that the change in net income (DNI) was increasing (mean and
median are greater than 0) during the pre-adoption period, but the opposite trend is observed during
the post-adoption period (negative DNI). In addition, the shareholders return (RETURN) has
decreased tremendously from 32.05 percent (mean) during the pre-adoption period to 7.87 percent
(mean) after the adoption of IFRS. Without controlling for other factors, Table 5 indicates that the
sample rms experienced signicant changes in variability (standard deviation) in the post-adoption
period than in the pre-adoption period. This could also partially reect the uncertainty in the
economic environment faced by the sample rms during the economic crisis, which emphasizes the
need to incorporate control variables in the regression analyses.
In terms of control variables, Table 5 shows that the sample rms have grown signicantly
larger (SIZE) after moving toward IFRS (both mean and median), despite showing insignicant
difference in the change in common stock (EISSUE) (both mean and median). Given that rms are
getting bigger (SIZE) but the level of common stock (EISSUE) remains relatively stable, it is not
surprising to nd that the leverage ratio (LEV) and the percentage change in total liabilities
(DISSUE) have increased following IFRS adoption. Moreover, the adoption of IFRS increases the
likelihood that the sample rms are audited by one of the Big 4 auditors
21
(AUD), possibly to
21
Previously, the ve largest auditing rms were known as the Big 5 auditors. With the collapse of Arthur
Andersen, the remaining four rms are collectively labeled as the Big 4 auditors. Both expressions equally
represent a group of the largest auditing rms in the accounting industry.
The Impact of Mandatory IFRS Adoption on Accounting Quality 133
Journal of International Accounting Research
Volume 11, No. 1, 2012
TABLE 5
Descriptive Statistics
Pre (n 688) Post (n 688)
Mean Median Std. Dev. Mean Median Std. Dev.
Test Variables
DNI 0.0060 0.0028 0.0794 0.0085*** 0.0026*** 0.0919***
DOCF 0.0074 0.0035 0.0948 0.0007 0.0016* 0.0828***
ACC 0.0332 0.0291 0.0787 0.0347 0.0234 0.0764
CF 0.0866 0.0858 0.1296 0.0994** 0.0818 0.1113***
SPOS 0.0465 0.0000 0.2107 0.0698* 0.0000 0.2549
LNEG 0.0451 0.0000 0.2076 0.0378 0.0000 0.1908
P 5.5676 3.3950 5.8873 8.0574*** 4.1400*** 9.7041***
NI/P 0.0536 0.0590 0.1033 0.0383** 0.0594 0.1393***
BVEPS 2.2565 1.5340 2.1987 3.1783*** 1.8944*** 3.3482***
NIPS 0.3016 0.1806 0.4369 0.4825*** 0.2615*** 0.7284***
RETURN 0.3205 0.2206 0.4770 0.0787*** 0.0490*** 0.3908***
Control Variables
SIZE 6.3523 6.0717 1.7512 6.9340*** 6.7380*** 1.6881
GROWTH 0.1931 0.1015 0.3929 0.1480** 0.0974 0.3337***
EISSUE 0.1920 0.0394 0.3650 0.2022 0.0356 0.4919***
LEV 1.6581 0.8716 2.7939 1.9260* 0.9859*** 3.1401***
DISSUE 0.2186 0.0634 0.5980 0.2556 0.1109** 0.6488**
TURN 0.8893 0.6769 0.7689 0.8361 0.7064 0.7013**
AUD 0.8372 1.0000 0.3694 0.8677 1.0000 0.3390
NUMEX 1.1831 1.0000 0.5696 1.1570 1.0000 0.5410
XLIST 0.0349 0.0000 0.1836 0.0349 0.0000 0.1836
CLOSE 0.3651 0.3744 0.2326 0.3453 0.3613 0.2299
*, **, *** Represent signicant difference between the pre-adoption and the post-adoption periods at the 10 percent, 5
percent, and 1 percent condence levels, respectively (two-tailed).
All continuous variables are winsorized at the 5 percent level.
Variable Denitions:
DNI change in annual net income, where net income is scaled by end-of-year total assets;
DOCFchange in annual net cash ows from operating activities, where cash ows is scaled by end-of-year total assets;
ACC net income less cash ow from operating activities, scaled by end-of-year total assets;
CF annual net cash ow from operating activities divided by total assets;
SPOS dummy variable that equals 1 for observations for which annual net income scaled by total assets is between 0
and 0.01, and 0 otherwise;
LNEG dummy variable that equals 1 for observations for which annual net income scaled by total assets is less than
0.20, and 0 otherwise;
P stock price three months after the scal year-end;
NIPS net income per share;
BVEPS book value of equity per share;
NI/P net income per share divided by beginning of year price;
RETURNshareholders total annual return from nine months before the scal year-end to three months after the scal
year-end;
SIZE natural logarithm market value of equity;
GROWTH percentage change in sales;
EISSUE percentage change in common stock;
LEV total liabilities divided by equity book value;
DISSUE percentage change in total liabilities;
(continued on next page)
134 Chua, Cheong, and Gould
Journal of International Accounting Research
Volume 11, No. 1, 2012
overcome the reporting complexity faced during the transition to new standards. Surprisingly, the
sample rms are, on average, listed on fewer stock exchanges (NUMEX) in the post-adoption
period (1.1570) than in the pre-adoption period (1.1837). Additionally, there is no change in terms
of rms listing on the U.S. stock exchanges
22
(XLIST) before and after the adoption. These two
preliminary ndings are contrary to the common argument that the use of IFRS facilitates access to
international capital markets (Jones and Higgins 2006).
Table 6 provides a Spearman correlation matrix for the continuous variables, with correlations
for the pre-adoption period being shown in Panels A and B and the post-adoption period being
shown in Panels C and D. Overall, correlations between the variables in both periods are modest,
which suggests that multicollinearity is not a substantive issue. The only exception is correlation
between share price (P) and net income per share (NIPS), in which correlation between these two
variables is the highest in both the pre-adoption and the post-adoption periods, and is greater than
0.70. Furthermore, accruals (ACC) and cash ows (CF) are also found to be negatively correlated in
both the pre-adoption (0.55 signicant at 1 percent) and the post-adoption periods (0.47
signicant at 1 percent), which is consistent with the prior expectation that the negative correlation
reects the natural outcome of accrual accounting (Leuz et al. 2003; Barth et al. 2008). In addition,
three variablesincluding the change in net income (DNI), the change in cash ows (DOCF), as
well as cash ows (CF)are all positively correlated at the 1 percent signicance level in both the
pre-adoption and the post-adoption periods. These positive relationships are also expected, given
that a rms reported earnings (e.g., DNI) should be reective of its own cash ow stream (e.g.,
DOCF and CF).
Empirical Results
Earnings Management
In terms of earnings management, the results reported in Panel A of Table 7 are mostly
consistent with our expectations that the adoption of IFRS in Australia had signicantly impacted
accounting quality.
As emphasized earlier, the analyses for the rst three earnings management measures focus on the
residuals from regressing each dependent variable on a specic set of control variables. Based on this
approach, a comparison of the residual variance (for DNI
#
) shows that the variability of the change in
net income is signicantly higher in the post-adoption period (0.0072) than in the pre-adoption period
(0.0056), suggesting that income-smoothing behavior has reduced following IFRS adoption.
To further support the rst nding, the second earnings management measure analyzes the
variability of the change in operating cash ows for both the pre-adoption and the post-adoption
TABLE 5 (continued)
TURN sales divided by total assets;
AUDdummy variable that equals 1 if the rms auditor is PwC, KPMG, Arthur Andersen, Ernst & Young, or Deloitte
Touche Tohmatsu, and 0 otherwise;
NUMEX number of exchanges on which a rms stock is listed;
XLISTdummy variable that equals 1 if the rm is listed on any U.S. stock exchange and Worldscope indicates that the
U.S. exchange is not the rms primary exchange, and 0 otherwise; and
CLOSE percentage of closely held shares of the rm as reported by Worldscope.
22
This can be interpreted from the variable XLIST because all sample rms with a listing on any U.S. stock
exchanges have their primary listing outside of the U.S.
The Impact of Mandatory IFRS Adoption on Accounting Quality 135
Journal of International Accounting Research
Volume 11, No. 1, 2012
TABLE 6
Spearman Correlation Matrix between Variables for the Pre-Adoption Period and the
Post-Adoption Period
Panel A: Pre-Adoption Period
DNI DOCF ACC CF P NI/P BVEPS NIPS
DNI 1.00
DOCF 0.42*** 1.00
ACC 0.10** 0.28*** 1.00
CF 0.22*** 0.35*** 0.55*** 1.00
P 0.03 0.03 0.04 0.21*** 1.00
NI/P 0.32*** 0.08** 0.23*** 0.19*** 0.06 1.00
BVEPS 0.05 0.04 0.01 0.06 0.59*** 0.25*** 1.00
NIPS 0.22*** 0.03 0.14*** 0.25*** 0.70*** 0.51*** 0.66*** 1.00
RETURN 0.31*** 0.17*** 0.10** 0.20*** 0.05 0.10** 0.13*** 0.03
SIZE 0.02 0.03 0.01 0.05 0.65*** 0.05 0.60*** 0.55***
GROWTH 0.18*** 0.10*** 0.07* 0.13*** 0.10** 0.18*** 0.03 0.17***
EISSUE 0.10*** 0.12*** 0.10** 0.21*** 0.01 0.12*** 0.05 0.05
LEV 0.07* 0.01 0.08** 0.04 0.35*** 0.13*** 0.31*** 0.32***
DISSUE 0.19*** 0.14*** 0.14*** 0.12*** 0.03 0.01 0.03 0.03
TURN 0.13*** 0.13*** 0.26*** 0.57*** 0.12*** 0.14*** 0.09** 0.13***
NUMEX 0.03 0.00 0.07* 0.06 0.14*** 0.07* 0.07* 0.05
CLOSE 0.00 0.03 0.04 0.00 0.16*** 0.02 0.19*** 0.15***
Panel B: Pre-Adoption Period (continued)
RETURN SIZE GROWTH EISSUE LEV DISSUE TURN NUMEX CLOSE
RETURN 1.00
SIZE 0.14*** 1.00
GROWTH 0.18*** 0.00 1.00
EISSUE 0.05 0.03 0.19*** 1.00
LEV 0.00 0.37*** 0.00 0.01 1.00
DISSUE 0.06 0.02 0.36*** 0.31*** 0.06 1.00
TURN 0.11*** 0.12*** 0.11*** 0.13*** 0.22*** 0.12*** 1.00
NUMEX 0.10** 0.29*** 0.15*** 0.03 0.07* 0.18*** 0.14*** 1.00
CLOSE 0.03 0.21*** 0.02 0.09** 0.07* 0.00 0.02 0.05 1.00
*, **, *** Represent the 10 percent, 5 percent and 1 percent level of signicance in two-tailed tests, respectively.
Panel C: Post-Adoption Period
DNI DOCF ACC CF P NI/P BVEPS NIPS
DNI 1.00
DOCF 0.35*** 1.00
ACC 0.18*** 0.28*** 1.00
CF 0.20*** 0.27*** 0.47*** 1.00
P 0.13*** 0.01 0.09** 0.20*** 1.00
NI/P 0.28*** 0.04 0.30*** 0.24*** 0.07* 1.00
BVEPS 0.04 0.02 0.16*** 0.14*** 0.65*** 0.18*** 1.00
NIPS 0.26*** 0.012 0.28*** 0.24*** 0.78*** 0.53*** 0.66*** 1.00
(continued on next page)
136 Chua, Cheong, and Gould
Journal of International Accounting Research
Volume 11, No. 1, 2012
periods to ascertain whether the observed increase in the volatility of income is also similarly found in
the volatility of cash ows. It is found that the ratio of the variance of the change in net income (DNI
#
)
to the variance of the change in operating cash ows (DOCF
#
) is substantially higher in the post-
adoption period (1.3250) than in the pre-adoption period (0.8070). Even without a statistical test to
determine whether the difference between the ratios is signicant, a change in the ratio from less than
1 to greater than 1 further indicates that it is not a higher volatility of cash ows that drives the higher
earnings variability in the post-adoption period relative to the pre-adoption period. By analyzing the
ratio of variances for the respective periods, only the pre-adoption period has a ratio signicantly less
than 1 (at the 0.01 level). This again provides an indication that the variability of the change in net
income in the pre-adoption period is below the variability of the change in operating cash ows. All
these results together suggest that the smoother earnings stream observed when Australian GAAP
were being used is not a result of smoother cash ow stream but more likely by the effect of accruals,
and that the adoption of IFRS has subsequently reversed that practice.
The result for our third measure of correlation between accruals (ACC) and cash ows (CF)
shows that the correlation between these two variables has become less negative in the post-
adoption period (0.4499) than in the pre-adoption period (0.4553). This corresponds with the results
on the rst two measures, although the difference is not signicant, to suggest that earnings
smoothing has reduced following the adoption of IFRS.
While all the ndings so far consistently support the notion that the adoption of IFRS has
lowered earnings management by way of smoothing, the signicant coefcient for POST in the
TABLE 6 (continued)
DNI DOCF ACC CF P NI/P BVEPS NIPS
RETURN 0.29*** 0.16*** 0.04 0.20*** 0.28*** 0.06 0.03 0.18***
SIZE 0.09** 0.01 0.07* 0.00 0.65*** 0.01 0.54*** 0.52***
GROWTH 0.16*** 0.18*** 0.02 0.16*** 0.20*** 0.09** 0.09** 0.18***
EISSUE 0.05 0.05 0.02 0.16*** 0.06 0.10*** 0.08** 0.00
LEV 0.01 0.01 0.07* 0.16*** 0.27*** 0.01 0.20*** 0.20***
DISSUE 0.06 0.14*** 0.15*** 0.04 0.09** 0.07* 0.00 0.15***
TURN 0.09** 0.07* 0.24*** 0.51*** 0.11*** 0.11*** 0.10*** 0.08**
NUMEX 0.03 0.04 0.05 0.09** 0.05 0.08** 0.01 0.01
CLOSE 0.03 0.00 0.07* 0.05 0.13*** 0.02 0.19*** 0.13***
Panel D: Post-Adoption Period (continued)
RETURN SIZE GROWTH EISSUE LEV DISSUE TURN NUMEX CLOSE
RETURN 1.00
SIZE 0.13*** 1.00
GROWTH 0.13*** 0.07* 1.00
EISSUE 0.02 0.11*** 0.22*** 1.00
LEV 0.04 0.32*** 0.09** 0.08** 1.00
DISSUE 0.12*** 0.03 0.39*** 0.19*** 0.16*** 1.00
TURN 0.07* 0.18*** 0.14*** 0.06 0.12*** 0.08** 1.00
NUMEX 0.03 0.19*** 0.08** 0.01 0.01 0.03 0.19*** 1.00
CLOSE 0.01 0.20*** 0.06 0.10*** 0.09** 0.06* 0.09** 0.01 1.00
*, **, *** Represent the 10 percent, 5 percent and 1 percent level of signicance in two-tailed tests, respectively.
The Impact of Mandatory IFRS Adoption on Accounting Quality 137
Journal of International Accounting Research
Volume 11, No. 1, 2012
TABLE 7
Accounting Quality Analysis
a
Panel A: Earnings Management Metrics
Prediction
Pre
(n 688)
Post
(n 688)
Eq. (1): Variability of DNI
#b
Post 6 Pre 0.0056 0.0072***
Eq. (2): Variability of DNI
#
over DOCF
#c,d
,1 0.8070
1.3250
Eq. (3): Correlation of ACC
#
and CF
#e
Post 6 Pre (0.4553) (0.4499)
Eq. (4): Small positive net income (SPOS)
f
6 0 1.8400***
Panel B: Timely Loss Recognition Metric
Prediction Pre (n 688)
Post
(n 688)
Eq. (5): Large negative net income (LNEG)
g
6 0 2.0834***
Panel C: Value Relevance Metrics
Prediction Pre (n 688)
Post
(n 688)
Eq. (6): Price model
h
Post 6 Pre 0.4827 0.5396***
Eq. (7): Return model
i
Good news Post 6 Pre (0.0001) (0.0005)
Bad news Post 6 Pre 0.0700 0.0869***
*** Represents signicant difference between the pre-adoption and the post-adoption periods at the 1 percent condence
level (two-tailed).
1.3427
Eq. (3): Correlation of ACC
#
and CF
#e
Post 6 Pre (0.4607) (0.4249)
Eq. (4): Small positive net income (SPOS)
f
6 0 1.3951**
Panel B: Timely Loss Recognition Metric
Prediction
Pre
(n 516)
Post
(n 516)
Eq. (5): Large negative net income (LNEG)
g
6 0 2.0453**
Panel C: Value Relevance Metrics
Prediction
Pre
(n 516)
Post
(n 516)
Eq. (6): Price model
h
Post 6 Pre 0.4557 0.5520***
Eq. (7): Return model
i
Good news Post 6 Pre (0.0010) (0.0033)
Bad news Post 6 Pre 0.0309 0.0835***
**, *** Represent signicant difference between the pre-adoption and the post-adoption periods at the 5 percent and 1
percent condence levels, respectively (two-tailed).
1.3312
Eq. (3): Correlation of ACC
#
and CF
#e
Post 6 Pre (0.4218) (0.4124)
Eq. (4): Small positive net income (SPOS)
f
6 0 1.1521
Panel B: Timely Loss Recognition Metric
Prediction
Pre
(n 528)
Post
(n 528)
Eq. (5): Large negative net income (LNEG)
g
6 0 1.8605*
Panel C: Value Relevance Metrics
Prediction
Pre
(n 528)
Post
(n 528)
Eq. (6): Price model
h
Post 6 Pre 0.4149 0.5451***
Eq. (7): Return model
i
Good news Post 6 Pre (0.0021) 0.0011
Bad news Post 6 Pre 0.0348 0.1303***
*, *** Represent signicant difference between the pre-adoption and the post-adoption periods at the 10 percent and 1
percent condence levels, respectively (two-tailed).