Introduction
This objective of this project is to research the quality of accounting information as well as the factors facilitating and inhibiting it. In the absence of encompassing accounting theory (Belkaoui, 2005, p. 193), the quality of accounting information may be understood in different ways, therefore this report will be guided by IFRS Conceptual Framework which states that the main qualitative characteristics of financial reporting are relevance and faithful representation (IFRS Foundation, 2011, p. A25). Relevance of the accounting information is generally construed as its usefulness for decision makers that have an interest in the reporting entity. However, things of quality come at a cost. Therefore the same Conceptual Framework has a cost constraint provision (p. A30) stating that “financial reporting imposes costs, and it is important that those costs are justified by the benefits of reporting that information”. IFRS are recognized as high quality accounting standards based on broader principles thereby limiting ability of managers to distort accounting information (Palepu et al, 2010, p. 8). However, it could be argued on the other hand that IFRS implementation and maintenance is costly.
It is also well recognized by accounting academics (e.g. Belkaoui, 2005) that accounting is a contextualized activity. The trend of the last decade was the worldwide acceptance of IFRS – high quality accounting standards which require reporting entities to produce high quality financial reporting. It is argued that accounting standards alone can not ensure financial reporting of high quality (Soderstrom and Sun, 2007). A number of other institutional factors play an important role in this respect. This report will seek to investigate different contexts in which accounting activity takes place to receive better insight into the factors facilitating the quality of accounting information on one hand and the factors inhibiting the quality of the accounting information. The objective factors which bring about lower quality accounting information include weak stock market, concentrated ownership of stocks, tax based accounting.
- What are the factors (legal, economical and financial) which have impact on accounting quality on the level of companies?
- Would reporting entities provide high quality financial reporting in the absence of economic incentives, taking into account considerable costs associated with such reporting?
Literature review
Elliott and Elliott (2009) assert that financial reporting is about communication. Of high importance is the communication of financial and non-financial information to the stakeholders that have financial interest in a company. Why is it the case? The answer can be obtained by looking at the financial reporting from the historical perspective. Richard (2012) argues that the rise of the big corporations, such as railways and other joint stock companies have called to life modern financial accounting. Davis et al (2003) describe that 19th century saw implementation of the big infrastructural projects such as railways in the US and explain how this development led to the gigantic mobilization of capital through joint stock companies. Indeed, such projects required huge investment and it was no more possible to finance these projects by means of proprietorships or partnerships as was the case in the past. A joint stock company (JSC) was invented in order to finance and operate such undertaking. However, in case of JSC there were thousands of shareholders, while management was separated from them (Mallin, 2010, p. 35). In order for the whole thing to work, a form of control was required and accounting was one of the tools. Davis et al (2003, p. 118) pointed out that in the United States were rules designed to yield data that could be used to analyze the various forces that affected net income—an analysis that was critical for evaluating common stocks by the investors. This sounds very similar to the main objective of financial reporting of our days – to help decision makers in making investment decisions (IFRS Foundation, 2011). On one hand this historical perspective shows the specific conditions under which the modern accounting thinking was developed and especially the important role played by the capital markets. However, on the other hand one can derive from this its limitations, which are in line with the extant academic research on the subject of the quality of accounting information.
Analyzing the determinants of the quality of accounting information Soderstrom and Sun (2007) refer to political and economic environment, financial reporting incentives and Generally Accepted Accounting Principles (GAAP). It follows from this reasoning that accounting rules are only one factor, and other important factors have great impact on the accounting quality.
Political and economic environment shapes ownership structure and corporate governance models of the companies. Mallin (2010, pp. 15-16) classifies countries into civil law and common law countries. Common law countries including the US, the UK are characterized by better investor protection and as a consequence their shareholding structure is very broad. In contrast to that, civil law countries provide lesser shareholder protection and therefore their shareholding structure is more concentrated (La Porta et al, 2008). It is worth noting that family controlled firms or firms with a large controlling shareholder are still most common form of ownership all the world over. The pertinent question is whether high quality reporting as required by IFRS is required in case of concentrated shareholding/family ownership. As argued by Ali and Hwang (2000) the Continental European characteristics of firms decrease the usefulness of accounting information, because the owning family or shareholder, having access to the internal company information, would attach less importance to formal public communication.
One more institutional factor identified by Ali and Hwang (2000) which has impact upon the importance of the financial information quality is orientation of a country’s financial system- it can be bank-oriented or market-oriented. The classical American or British corporation would be market oriented, which means it relies on the share market for its financing needs, while a typical continental European company would approach its bank. Being a major creditor of such a corporation, the bank does not need to rely only on public reporting, but would most likely have timely access to wider of management information.
The limitation of the above studies is that they looked at clusters of countries or individual countries as a whole. Such an approach certainly helped the researchers have broad view over the general institutional setting, while important details on more micro-level, a company level is described to lesser extent.
In order to achieve the report objectives the researcher plans to perform detailed literature review and qualitative empirical analysis including case studies and interviews. As parts of qualitative analysis it is planned to deploy a structured questionnaire, covering the key aspects relating to the accounting information quality such factors which have impact upon it, as identified from the literature review.
Concerning the first research question a detailed documentary research is to be made, with the objective to identify literature relevant for the accounting quality and gathering institutional factors which have impact upon quality of accounting information.
Based on this foundation the researcher will interview the representatives from the accounting and finance milieu to discuss the factors affecting the quality of accounting information, its costliness on the firms level, also seeking other explanations and clues.
A case study of a number of listed companies with different parameters will be made and their accounting quality is to be compared based on pre-determined ranking system which will be modeled after IFRS disclosure checklists published by big four (e.g. E&Y, 2014). The checklist will be considerably simplified to focus only on certain areas, while big four checklists are very detailed.
The research methods are limited to qualitative ones with no quantitative methods used. Therefore its results may be limited in application to the specific circumstances of the cases reviewed and can be generalized only with caution.
The researcher does not foresee considerable ethical issues during the project. However, there will be encounters with real interviewees and the interviews will be conducted only with their consent. Also, identities of the interviewees will be hidden to protect their privacy. Regarding the case studies, as all information will be obtained from the public sources such as stock exchange filings, there is no need for additional confidentiality. Possible challenges would be to find out and get consent of the interviewees for the project.
References
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