In December 2007, the U.S. Securities and Exchange Commission (SEC) adopted Securities Act Release No. 8879, “Acceptance from Foreign Private Issuers of Financial Statements Prepared in Accordance with IFRS without Reconciliation to U.S. GAAP.” The SEC’s new rule applies to financial statements issued for fiscal years ending after November 15, 2007, and interim periods after the effective date. The ruling has significant implications for U.S. firms, U.S. capital markets, and accounting practitioners and researchers.
Prior to 2008, the SEC required foreign registrants to file a Form 20-F, analogous to a Form 10-K, within six months after the fiscal year-end. In a Form 20-F, foreign private issuers reconciled their earnings and stockholders’ equity measures to U.S. GAAP. The SEC’s main motivation for the requirement was to protect U.S. investors who may not be familiar with non-U.S. accounting practices (Siconolfi and Salwen, 1992). However, the reconciliation requirement also suggests that U.S. GAAP is not only superior to foreign accounting standards, but is also superior to standards issued by the International Accounting Standards Board (IASB). (Note 1)
In contrast, the new ruling indicates the SEC’s confidence that IFRS represents a single set of high-quality accounting standards and that financial reports prepared under IFRS are as informative and useful as those prepared under U.S. GAAP. However, it is noteworthy that the Financial Accounting Standards Committee (FASC) and the Financial Reporting Policy Committee (FRPC), both part of the American Accounting Association (AAA), reached dissimilar conclusions in recent studies of the value of 20-F reconciliations to investors. The FASC argues that “allowing foreign companies to use IFRS without costly reconciliations to U.S. GAAP is likely to make U.S. stock exchanges more competitive…” (AAA, 2008a), whereas the FRPC indicates that “the research on the U.S. GAAP-IFRS reconciliation suggests that material differences between IFRS and U.S. GAAP exist and that
information contained in the reconciliations is reflected in investment decisions made by U.S. investors” (AAA, 2008b). The FRPC concludes, after reviewing the academic literature, that it “does not support the SEC’s decision to eliminate the U.S. GAAP-IFRS reconciliation requirement for foreign-private issuers” (AAA, 2008b).
Users of foreign firms’ financial statements also disagree among themselves on the SEC’s decision to allow IFRS filers to remove the reconciliation to U.S. GAAP. The CFA Institute, which represents investment analysts and portfolio managers, states in its comment letter to the SEC that “to the extent accounting standards have not yet converged (or new differences develop), investment professionals rely on the reconciliation as an efficient and cost-effective way of bringing to their attention the material differences in accounting” (CFA Institute, 2007). The CFA Institute further argues that “we believe that it is premature to eliminate this requirement at this time” (CFA Institute, 2007). In contrast, Fitch Ratings, the third largest rating agency, argues that it “does not pay very much attention to US GAAP reconciliations in 20-F reports and does not consider that their elimination would have a substantial impact on [its] ability to conduct analysis” (Fitch Ratings, 2007).
This policy debate on whether IFRS reporting is comparable to U.S. GAAP is what motivates this study. The controversy is complex because the features of any financial reporting system affect the application of any set of accounting standards (Barth, Landsman, & Lang, 2008). Although the SEC ruling is intended as a step toward convergence of U.S. GAAP and IFRS, the decision to waive the U.S. GAAP reconciliation requirement and allow IFRS is controversial. Against this background and concern, this paper examines properties of accounting information for cross-listed foreign firms on the U.S. stock exchanges across two periods: the U.S. GAAP reconciliation period and the IFRS reporting period.
Our investigation starts by comparing accounting-quality metrics for foreign issuers that apply IFRS to those for a matched sample of foreign firms that do not in the IFRS reporting periods. The results indicate that foreign issuers applying IFRS demonstrate more earnings management and less timely recognition of losses than do foreign firms filing U.S. GAAP reconciliations in the IFRS reporting period. However, the results also show that IFRS firms exhibit a higher association of accounting amounts with share prices and returns. Differences in accounting quality between the two sets of firms in the U.S. GAAP reconciliation period do not account for the IFRS reporting-period differences. We also compare accounting-quality metrics for IFRS firms in the periods before and after the SEC waiver and examine whether the change in accounting quality for IFRS firms between the U.S. GAAP reconciliation and IFRS reporting periods is different from that for their counterparts. The results document that foreign firms filing U.S. GAAP reconciliations experience a greater improvement in accounting quality in terms of less earnings smoothing and more timely recognition of losses than do foreign issuers adopting IFRS between the U.S. GAAP reconciliation and IFRS reporting periods. Overall, the combined evidence suggests that for non-U.S. firms, applying IFRS does not enhance financial reporting comparability with firms filing U.S. GAAP reconciliations.
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(Author: Chia-Ling Chao, Shwu-Min Horng