A cross-country analysis of IFRSreconciliation statements

Suzanne Fifield, Gary Finningham, Alison Fox and David PowerUniversity of Dundee, Dundee, UK, and

Monica VenezianiUniversity of Brescia, Brescia, Italy

Abstract

Purpose – One of the most fundamental changes to affect financial reporting in recent years has beenthe introduction of International Financial Reporting Standards (IFRS). This paper aims to examinethe nature of the Income Statement and Net Equity IFRS adjustments for a sample of companies fromthe UK, Ireland and Italy following the introduction of IFRS.Design/methodology/approach – A sample of IFRS Reconciliation Statements are examined toidentify the most significant IFRS adjustments. Using an index of conservatism, these amounts arefurther analysed to assess their impact on the accounting numbers reported under previous nationalGAAP.Findings – For all three countries, the IFRS profit was greater than that reported under previousnational GAAP. IFRS also had a significant effect on net worth; while UK and Italian companiesexperienced an increase in equity upon the adoption of IFRS, the Irish firms in the sample recorded adecrease. The analysis also indicated that the impact of IFRS on profit and net worth was primarilyattributable to a few core standards including IFRS 2, IFRS 3, IFRS 5, IAS 10, IAS 12, IAS 16, IAS 17,IAS 19, IAS 38 and IAS 39.Practical implications – A multi-country perspective for future IFRS research is required as theimpact of individual IFRS varies in importance from one country to another.Originality/value – By analysing the IFRS that have had a significant impact on accountingnumbers prepared under previous national GAAP, opportunities for future research are identified.

Keywords International finance, Financial reporting, United Kingdom, Italy, Ireland

Paper type Research paper

1. IntroductionOne of the most fundamental changes to affect financial reporting in recent times hasbeen the introduction of International Financial Reporting Standards (IFRS). Thesestandards were applied to the consolidated financial statements of European Union(EU)-listed companies for annual accounting periods beginning on or after 1 January2005. Previous year comparatives were also required to be shown in the first set offinancial statements published under the new rules, together with reconciliations to theequity and profit figures that were calculated according to previous nationalaccounting standards. Therefore, in the EU, the basis underpinning the preparation ofthe annual report, as well as the components, format and presentation of financialstatements, have changed dramatically.

Preliminary evidence suggested that changes to the financial statements weresubstantial. For example, in 2005, Vodafone plc reported that the application of IFRSresulted in the restatement of a £1.9 billion loss into a £4.5 billion profit in its financialstatements because goodwill was no longer written off to the income statement(Financial Times, 2005a). Similarly, in the same year, ICI highlighted the impact of IFRSon corporate earnings when it revealed that the application of the new rules boosted its

The current issue and full text archive of this journal is available atwww.emeraldinsight.com/0967-5426.htm

Journal of Applied AccountingResearchVol. 12 No. 1, 2011pp. 26-42r Emerald Group Publishing Limited0967-5426DOI 10.1108/09675421111130595 Monica Veneziani contributed to this project with particular reference to Italy.

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2004 profit by 6 per cent, primarily because of changes in the accounting treatment ofpensions, goodwill, derivatives and share options (Financial Times, 2005b). Further,Astra Zeneca’s 2005 re-stated results showed that earnings per share had decreasedby $0.02 and net assets had decreased by $48 million when it adopted InternationalGAAP (Accountancy, 2005), while BA announced that it would not be able to pay a 2005dividend because of its £1.4 billion pension deficit under International AccountingStandard (IAS) 19 (Financial Times, 2005c). Therefore, a study of the actual impact ofIFRS adoption is required so that general conclusions about the financial effects of thenew standards can be made[1].

This paper reports an analysis of the IFRS reconciliation statements of a largesample of EU companies from the UK, Ireland and Italy. It investigates the impact ofIFRS on both the net profit and the net worth of the sample companies as well asexamining the effect of individual international standards. A cross-countrycomparison between the three countries is also made. Therefore, this study is notintended as a theoretical piece of work, but rather serves to inform subsequentresearch. The remainder of this paper is organised as follows. Section 2 summarises thedevelopments towards the international harmonisation of accounting standards in theEU and reviews prior research that has identified those IFRSs that have provedproblematic due to the significant financial impact they have had uponimplementation. The financial reporting environments of the countries examined inthis study are described in Section 3. Section 4 details the dataset used and presentssome preliminary statistics while the method of analysis adopted, and the results, arediscussed in Section 5. Finally, Section 6 offers a number of concluding observations.

2. The EU Implementation of IFRSUntil the 1990s, companies from different countries prepared their financial statementsaccording to different national GAAPs that meant that direct comparisons were notpossible. As a result, reconciliation statements were required in some capital markets –especially the USA (Street and Bryant, 2000; Haller, 2002). Over time, as the costs ofsuch reconciliations increased, the benefits from harmonising the financial reportingrequirements of different countries became more apparent. In addition, as the processof globalisation gathered pace, it was argued that harmonisation would enablestakeholders anywhere in the world to use a set of financial statements withoutworrying about different accounting and disclosure treatments that existed in variouscountries at that time (Street and Shaughnessy, 1998). It would also allow companieswith subsidiaries in different countries to produce financial statements according to asingle set of accounting principles (Buchanan, 2003).

One of the main driving forces behind the harmonisation process was the launch ofthe International Accounting Standards Committee (IASC) in 1973. Since the IASC’sinception, professional accountancy bodies from different countries have workedtogether on this committee to obtain a consensus about a common set of accountingrules. From 1973 until 2001, the IASC issued IASs which were approved by a majorityof the ten member countries (Australia, Canada, France, Germany, Ireland, Japan,Mexico, The Netherlands, the UK and the USA) (ICAEW, 2006)[2]. On 1 April 2001, theInternational Accounting Standards Board (IASB) replaced the IASC and the new IASsbecame known as IFRSs. Table I contains a list of current IFRS and IAS.

In June 2002, the EU mandated that publicly traded EU incorporated companies hadto prepare consolidated accounts under International GAAP (European Commission,2001). At the time, it was estimated that this regulation would potentially affect 7,000

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European companies ( Jermakowicz and Gornik-Tomaszewski, 2006); as of 2001, only275 were actually reporting under IAS (Haller, 2002). Surprisingly, Dutch, Irish and UKfirms were least in favour of the new regulation, although their standards were alreadyclosely aligned with those of the IASB; it has been argued that companies in thesecountries believe their national accounting standards to be superior (Haller, 2002).

Prior research has indicated that the implementation of IFRS has caused preparersof financial statements a variety of problems for a number of reasons (Dunne et al.,2008). For example, the adoption of some IFRS has required many companies to changethe way that their underlying information systems capture and categorise accountingdata. In addition, some IFRS have resulted in increased disclosure in the financial

Panel A: IFRS1. First-time adoption of International Financial Reporting Standards2. Share-based payment3. Business combinations4. Insurance contracts5. Non-current assets held for sale and discounted operations6. Exploration for and evaluation of mineral resources7. Financial instruments: disclosures8. Operating segments

Panel B: IAS1. Presentation of financial statements2. Inventories7. Statement of cashflows8. Accounting policies, changes in accounting estimates and errors

10. Events after the balance sheet date11. Construction contracts12. Income taxes16. Property, plant and equipment17. Leases18. Revenue19. Employee benefits20. Accounting for government grants and disclosure of government assistance21. The effects of changes in foreign exchange rates23. Borrowing costs24. Related party disclosures26. Accounting and reporting by retirement benefit plans27. Consolidated and separate financial statements28. Investments in associates29. Financial reporting in hyperinflationary economics31. Interests in joint ventures32. Financial instruments: presentation33. Earnings per share34. Interim financial reporting36. Impairment of assets37. Provisions, contingent liabilities and contingent assets38. Intangible assets39. Financial instruments: recognition and measurement40. Investment property41. Agriculture

Note: This table summarises the current international accounting standards in publication, whereIFRS represents International Financial Reporting Standards issued by the IASB and IAS representsInternational Accounting Standards issued by the IASC

Table I.Existing IFRS and IAS

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statements and others have had a material financial impact on the income statementand/or balance sheet.

Most concerns, within an EU context, have focused on the disclosure requirementsof IAS 39 “Financial instruments: recognition and measurement”, especially for largerfirms in certain industries (PwC, 2006a, b, 2007). However, the implementation of IAS39 has also required many companies to account for, and disclose, their financialinstruments for the first time, recognise derivatives on the balance sheet and employhedge accounting practices (Cairns, 2004). Similarly, the implementation of IAS 19“Employee benefits” has also caused problems in financial statements in terms of thecomplexity of the calculations that are required and their impact on the volatility of theincome statement numbers (Fearnley and Hines, 2002; Cairns, 2004; Jermakowicz andGornik-Tomaszewski, 2006; KPMG, 2006; PwC, 2007).

A third standard that has been the focus of much attention in the literature is IFRS 2“Share-based payments” (Jermakowicz and Gornik-Tomaszewski, 2006; PwC, 2006c,2007). For example, Ernst & Young (2006) note that 90 per cent of companies of thecompanies in their study had charges to the income statement under this standardwhere previously there had been little disclosure. Likewise, IFRS 3 “Businesscombinations” and IAS 36 “Impairment of assets” have caused much controversybecause of their impact on the volatility of the income statement numbers(Jermakowicz and Gornik-Tomaszewski, 2006; PwC, 2006a, c, 2007). For example,Ernst & Young (2006) reported that 50 per cent of the companies in its sample reportedimpairment to goodwill and 67 per cent reported impairments to assets generally whenthese standards were implemented.

IAS 12 “Income taxes”, and the associated change in deferred taxation, is anotherstandard that has caused concern (Fearnley and Hines, 2002; PwC, 2006a), althoughKPMG (2006) found that FTSE 250 companies were more affected by changes todeferred tax rules than their counterparts in the FTSE 100.

Other standards that have also been cited as problematic because of their financialimpact include, IAS 16 “Property, plant and equipment” (PwC, 2006a), IAS 18 “Revenue”(PwC, 2007), IAS 37 “Provisions, contingent liabilities and contingent assets”( Jermakowicz and Gornik-Tomaszewski, 2006), IAS 38 “Intangible assets” (Fearnleyand Hines, 2002; Jermakowicz and Gornik-Tomaszewski, 2006; PwC, 2006b, c, 2007) andIAS 17 “Leases” as exemplified by Sir David Tweedie’s well-publicised joke that he wouldlike to fly on an aeroplane that is actually owned by an airline before he dies (ICAS, 2007).

A small number of studies have analysed the implementation of IFRS, most notablyAisbitt (2006) who examined the reconciliation statements of the FTSE 100 companies.Aisbitt (2006) discovered that, although the overall effect of IFRS on FTSE 100companies was relatively small, the change in convention for line items was significant.There was a sectoral bias whereby healthcare firms in the sample experienced anegative impact on net equity upon adopting IFRS while companies in the consumergoods sector recorded a positive impact on net equity. This finding differs with theresults of Jermakowicz and Gornik-Tomaszewski (2006) who noted that net equity roseby 11 per cent for their sample of EU-firms upon the adoption of IFRS.

In Aisbitt’s analysis, the standards that had the biggest effect on net equitywere IAS 19 (�15 per cent), IAS 16 (þ 11 per cent), IAS 7 (þ 8 per cent), IAS 12(þ 6 per cent), IFRS 3 (�4 per cent) and IAS 39 (þ 4 per cent). The standardsthat appeared most frequently in the IFRS reconciliation statement included IFRS 2,IAS 10, IAS 12, IAS 16, IAS 17, IAS 18, IAS 19, IAS 21 and IAS 32/29. Refer to Table Ifor details of the accounting issues to which these standards relate.

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3. The UK, Irish and Italian financial reporting environmentsThe UK, Ireland and Italy were selected for analysis in this paper to help explain anydifferential application across the three jurisdictions. While the reporting environmentof the UK and Ireland are very similar, that of Italy is quite different. The regulation ofthe UK and Irish financial reporting environments originates from three sources:

(1) accounting standards[3];

(2) Stock Exchange requirements[4]; and

(3) company law[5].

The requirements of accounting standards and the stock exchange tend to inform thecontent of company law, which in effect, codifies best practice. Also, UK and Irishfinancial statements provide information to a wide range of stakeholders.

In Italy, Roman law prevails; this system is characterised by the importance ofwritten codified law, as opposed to custom and usage. Accounting standards are issuedby a rule-making body called Organismo Italiano di Contabilita (OIC) and, togetherwith the provisions of the Civil Code, the resulting accounting standards contributeto the formation of financial statements. However, the role of accounting standards issubordinate; in other words, they are not compulsory but have an integrative andinterpretative function with respect to the provision of the law (Marchi, 2000). In thiscountry, the most common type of company is the small-medium enterprise (SME). Themajority shareholdings in such companies are usually held within a single family and themain source of finance tends to be the bank. In this environment, accounting practicetypically generates financial statement disclosure which meets legal requirements andprovides communication of a general nature only (Vigano, 1990). This role for disclosurecontrasts with the Anglo-Saxon model, where there are large numbers of management-runcompanies that rely on millions of private shareholders for finance. In countries such asItaly, creditors as opposed to investors, are considered to be the main users of corporatefinancial statements. Furthermore, in this environment the stock exchange is characterisedby a small number of listed companies and, hence, it does not act as a regulatory body.

Therefore, from an accounting standpoint, Italian companies apply accountingregulations which class creditors as the primary user/stakeholder and assume thatthey have not changed significantly over time. By contrast, the IFRS regime isdesigned primarily around the Anglo-Saxon model which results in some difficultiesfor Italian preparers of financial statements. In addition to these differences, there isalso diversity in some of the qualitative characteristics such as prudence[6], the basicassessment criterion[7] and the principle of substance over form (Di Pietra, 2002;Provasoli, 2003; Adamo, 2004)[8].

4. Data and summary statisticsThe aim of this research is to examine how the introduction of international GAAP hasimpacted on the financial reporting practices of a sample of adopting companies in theUK, Ireland and Italy. The analysis focuses on the reconciliation statements includedin the first annual reports produced under IFRS from a sample of companies in thesethree countries. In the UK, the FTSE 100 firms and a random sample of “other” listedfirms were selected for inclusion in the analysis. The initial UK sample consisted of171 companies, although 39 firms had to be excluded for reasons set out in Table II;a sample of 132 thus resulted. Ten Irish firms were randomly selected from thecompanies listed on the Irish Stock Exchange. The companies listed on the MIB 30 as

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at 31 December 2004 represented the initial group of companies chosen for the Italianinvestigation. The MIB 30 consists of the 30 largest and most frequently tradedcompanies in Italy. Three of these firms had to be excluded from the analysis; furtherdetails regarding the reasons for exclusion are given in Table II. Thus, in total, 169post-IFRS annual reports were analysed for this research.

IFRS 1 specifically required first-time adopters to:

(1) reconcile its equity reported under national GAAP to its equity under IFRS[9];and

(2) reconcile its most recent annual profit/loss reported under national GAAP tothe equivalent IFRS profit/loss[10].

Although the standard does not prescribe a format for the reconciliation statement, theimplementation guidance does contain an example of a line-by-line reconciliation of thefinancial statements. Of the 169 companies that produced a line-by-line reconciliation,only a subset provided information that enabled transitional adjustments to bematched to specific IFRSs; therefore, further companies were omitted from theinvestigation as the absence of a line-by-line reconciliation did not allow the impact ofindividual standards to be examined. The final sample for the income statementanalysis consisted of 122 companies: 88 from the UK, seven from Ireland and 27 fromItaly. The final sample for the balance sheet analysis included 125 companies: 92 fromthe UK, six from Ireland and 27 from Italy.

For each of these companies, the reconciliations were grouped according to therelevant standard and the amount of the adjustment was expressed as a percentage ofthe total equity adjustment in the balance sheet or total profit (loss) adjustment in theincome statement. These percentages were then analysed statistically and descriptiveinformation produced. This information is reported for the whole sample in Table III.The left-hand half of this table (Table III) relates to the income statement adjustmentswhile the right-hand half relates to the balance sheet adjustments.

Table III is each split into nine columns; the first outlines the accounting standardassociated with the IFRS adjustment while the next four columns supply descriptivestatistics for the income statement adjustments; the final four columns provide

UK Ireland Italy Total

Initial sample considered 171 10 30 211Companies excluded

Data unavailable (14) (0) (0) (14)Change in ownership status (15) (0) (1) (16)Financial statements not prepared under IFRS (4) (0) (2) (6)

Sample examined 138 10 27 175Companies excluded

Reconciliation statement could not be analysed (6) (0) (0) (6)Sample for analysis 132 10 27 169Subsample analysed: income statement 88 7 27 122Subsample analysed: balance sheet 92 6 27 130

Notes: This table details the sample used in the analysis of reconciliation statement. In particular, thetable outlines the initial sample of companies considered and the reasons why certain companies wereexcluded from the investigation

Table II.Sample details

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descriptive information for the balance sheet adjustments. In particular, the mean sizeof each adjustment as a percentage of the total adjustment, along with its standarddeviation, is provided. The minimum and maximum percentage size of the adjustmentassociated with each standard across all the companies in the sample is displayed inorder to provide some insight about the range of adjustments made by the samplefirms for the different IFRS.

IFRS income statement adjustments IFRS equity adjustmentsMean SD Min Max Mean SD Min Max

IFRS 1 1.26 13.05 0.00 137.50 5.17 48.64 �16.79 508.20IFRS 2 �41.45 403.03 �2,875.00 2,200.00 5.13 19.82 �21.05 149.58IFRS 3 114.79 547.03 �1,050.00 5,447.37 28.65 57.36 �210.16 329.11IFRS 4 1.99 40.03 �265.29 260.98 �2.69 20.34 �189.47 28.79IFRS 5 �11.52 127.07 �1,337.50 40.93 0.00 0.00 0.00 0.03IAS 1 1.35 10.05 �0.33 77.70 1.51 16.01 0.00 170.17IAS 2 0.57 5.45 0.00 57.35 0.96 7.07 �3.78 68.05IAS 10 3.02 18.09 �0.01 122.79 101.66 459.54 0.00 4,822.73IAS 12 10.41 127.67 �244.64 1,130.43 �10.72 346.83 �1,688.98 3,136.36IAS 16 �3.00 29.67 �289.41 45.16 14.13 113.69 �336.44 925.97IAS 17 11.14 255.30 �912.50 2,512.50 �6.86 24.61 �143.79 8.59IAS 18 0.85 14.15 �61.29 120.49 �2.40 15.04 �129.73 18.00IAS 19 10.69 140.50 �352.11 1,075.00 �165.27 864.37 �9,136.36 78.26IAS 21 �2.64 19.72 �120.44 42.58 0.12 2.00 �7.42 17.44IAS 23 0.40 3.25 �0.86 33.33 1.64 9.75 0.00 80.95IAS 27 5.43 66.76 �140.00 684.21 0.16 6.01 �47.04 28.95IAS 28 �9.70 112.14 �1,173.77 111.18 �0.15 9.34 �66.67 70.79IAS 31 0.25 3.97 �13.37 29.90 �0.42 5.47 �56.96 10.32IAS 32 �0.06 0.40 �3.49 0.00 �3.26 21.92 �206.33 23.35IAS 36 �2.73 36.62 �367.74 102.17 �0.87 6.60 �34.02 30.92IAS 37 �9.26 48.89 �320.33 127.59 7.88 42.57 �30.88 378.72IAS 38 �10.14 397.93 �3,863.16 1,467.74 10.88 61.26 �114.29 481.82IAS 39 �47.21 225.73 �1,477.42 96.79 2.08 40.16 �246.22 190.40IAS 40 5.11 24.42 �1.96 157.48 �0.18 1.11 �8.83 0.00IAS 41 0.86 9.33 �3.57 98.23 0.98 10.38 �0.23 110.37IAS 28/IAS 31 0.13 2.47 �13.79 19.96 0.10 1.46 �6.50 13.85IAS 32/IAS 39 0.21 16.96 �110.14 73.33 4.16 39.13 �101.67 373.40IAS 27, 28 and 31 1.22 10.30 0.00 106.88 22.87 136.87 �119.74 1,264.83Goodwill 7.70 30.41 �83.67 166.41 1.79 9.95 0.00 88.98IFRS 3 and IAS 38 2.37 14.42 0.00 96.79 �1.22 13.00 �138.16 0.00IFRS 4 and IAS 39 1.63 19.08 �18.67 200.00 0.00 0.04 0.00 0.42IAS 28 and IAS 21 �0.11 1.11 �11.73 0.00 �3.21 25.62 �142.86 116.63IAS 32, 39 and IFRS 4 0.00 0.00 0.00 0.00 �0.21 1.31 �10.22 0.00Minority interests �0.61 4.65 �40.00 1.73 3.16 51.70 �234.36 410.53Reallocations 0.59 6.20 0.00 65.32 �2.04 19.31 �203.72 0.00Asset swaps 0.03 0.28 0.00 3.00 �1.54 14.37 �121.05 53.42Unclassified (other) 0.59 120.44 �850.00 635.42 �10.13 106.31 �1,120.78 90.35

Notes: This table reports the IFRS adjustments calculated as a percentage of the total adjustment to theprofit (loss) and equity under national GAAP as at 31 December 2004. Specifically, summary statistics arereported: Mean is the average, SD is the standard deviation, Median is the mid-point while Min and Max arethe minimum and maximum values. In calculating these summary statistics, the absolute value of the totaladjustment was used in the denominator of the percentage calculation

Table III.Descriptive statistics forthe total sample

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A distinctive picture emerges from an analysis of the income statement adjustmentsin Table III. On average, the positive impact of the reconciliation to IFRS GAAP wasmainly due to IFRS 3 (114.79 per cent), IAS 12 (10.41 per cent), IAS 17 (11.14 per cent)and IAS 19 (10.69 per cent). However, the positive impact of these adjustments on totalprofit under national GAAP was offset to some extent by changes required underIFRS 2 (�41.45 per cent), IFRS 5 (�11.52 per cent), IAS 38 (�10.14 per cent) and IAS 39(�47.21 per cent). The standard deviation values in the income statement part ofTable III are sizeable for some of the accounting standards (IFRS 2 (403.03 per cent),IFRS 3 (547.03 per cent), IAS 17 (255.30 per cent), IAS 38 (397.93 per cent) and IAS 39(225.73 per cent)) indicating that there was considerable variation in their impact on thetotal adjustment for the sample of firms. This view is confirmed by the minimum andmaximum values which are very large in a number of cases. For example, the range ofadjustments for IAS 38 varies from �3,863.16 per cent to þ 1,467.74 per cent of thetotal adjustment to profit (loss) under national GAAP. Eleven IASs had no materialimpact on the income statement reconciliation figures and these have therefore beenexcluded from Table III (IAS 7, IAS 8, IAS 11, IAS 14, IAS 20, IAS 24, IAS 26, IAS 29,IAS 30, IAS 33 and IAS 34).

A visual inspection of the balance sheet half of Table III also reveals a number ofinteresting findings. First, the overall impact on the balance sheet of implementingIFRS for this sample of firms varied from standard to standard. The main standardswhich increased total equity were those associated with IAS 10 (101.66 per cent), IFRS3 (28.65 per cent), IAS 38 (10.88 per cent) and IAS 16 (14.13 per cent). These positiveadjustments to total equity were partly offset by changes put through under IAS 19(�165.27 per cent) and IAS 12 (�10.72 per cent). For some of the sample firms, theinformation supplied by companies in their reconciliation statements did not permitthe allocation of an adjustment amount to one specific standard; in these few cases, themultiple standards are shown in the tables and involve sizeable average percentagevalues in certain circumstances.

Second, these mean percentage adjustments mask a wide spread of values acrossthe sample firms. The four largest standard deviation figures relate to IAS 19 (864.37per cent), IAS 10 (459.54 per cent), IAS 12 (346.83 per cent) and IAS 16 (113.69 per cent).This impression is confirmed by an analysis of the minimum and maximumpercentage adjustment values. The gap between these figures is very big for several ofthe accounting standards suggesting that the impact of different IFRS varied fromcompany to company. For example, the adjustments associated with IAS 12 range froma low of �1,688.98 per cent to a high of 3,136.36 per cent of the total adjustment to theequity figure under national GAAP. The spread of the percentage of the adjustment forIAS 19 ranges from �9,136.36 per cent to 78.26 per cent.

5. An index of conservatismThe IFRS disclosures of companies from the three sample countries were alsoexamined by means of a “conservatism” index. This index, which was developed byGray (1980), is useful for assessing whether there are material quantitative differencesin profits and equity reported under IFRS as compared to that reported in accordancewith national GAAP[11]. To examine the impact on profit from moving from nationalGAAP to IFRS, the index was calculated as:

1� ðProfitNational GAAP � ProfitIFRSÞProfitNational GAAPj j ð1Þ

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Similarly, to assess the extent of the differences in equity reported using nationalGAAP and IFRS, the index was calculated as:

1� ðEquityNational GAAP � EquityIFRSÞEquityNational GAAPj j ð2Þ

If the index assumes a value greater than 1, this indicates that profits or equityreported using IFRS are less “conservative” than those reported using national GAAP.By contrast, an index value of less than 1 means that IFRS-based figures are more“conservative” than those produced using national GAAP. An index value equal to 1indicates neutrality between IFRS-based and national GAAP-based figures[12].

In addition to calculating an overall index of conservatism for profit and equity, therelative effect of individual adjustments required under each IAS was also examinedby constructing partial indices as:

1� ðPartial adjustmentÞProfitNational GAAPj j ð3Þ

and

1� ðPartial adjustmentÞEquityNational GAAPj j ð4Þ

Equations (1-4) were used to calculate index values for each of the sample companies.The index values were then averaged across the companies for each of the three samplecountries and the results reported in Table IV for the income statement and in Table Vfor the balance sheet. In particular, Tables IV and V show that, for each country, themean and standard deviation for the overall conservatism index as well as for each ofthe partial indices. The tables also report the results from a t-test that was used todetermine whether the mean index values were significantly different from the neutralvalue of 1[13].

Perhaps the most salient point arising from an examination of Table IV relatesto the mean index values that were calculated for the profit figures reported underIFRS and national GAAP. In particular, the table shows that, on average, the profitreported under IFRS for the sample companies was higher than that reported underUK, Irish or Italian GAAP. More specifically, the results show that profits under IFRSwere 101.0 per cent, 23.6 per cent and 16.5 per cent higher than their value underUK, Irish and Italian GAAP, respectively. Furthermore, reported profits using IFRSwere significantly greater than those reported under UK and Italian GAAP at the1 per cent and 10 per cent level, respectively; the p-value for the UK conservatismindex is 0.010, while the corresponding figure for the Italian conservatism index is0.052. Thus, the results suggest that IFRS had a significant impact on the reportedprofits of UK and Italian firms, although the impact was greater for the UK firms inthe sample.

The effect of individual IASs also varied across the sample countries. For example,the number of standards that resulted in a statistically significant adjustment washighest (lowest) for the UK (Irish) firms in the sample; significant p-values wereobtained for two UK and two Italian partial indices while only 1 adjustment wassignificant for the Irish companies[14]. Further examination of these results revealsthat IFRS 3 had a significant negative impact on the income statement of UK and

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Italian companies; profits under IFRS were 31.8 per cent (UK firms) and 19.2 per cent(Italian firms) lower than under national GAAP because of the differences in thetreatment of business combinations.

Several standards had no effect on the profits reported by UK, Irish and Italiancompanies and have therefore been excluded from Table IV. Eleven of these “zeroimpact” standards were common to companies in all three countries (IAS 7, IAS 8, IAS11, IAS 14, IAS 20, IAS 24, IAS 26, IAS 29, IAS 30, IAS 33 and IAS 34)[15].

UK Ireland ItalyIndex Mean StDev p-value Mean StDev p-value Mean StDev p-value

Profit 2.010 3.585 0.010*** 1.236 0.546 0.296 1.165 0.422 0.052*IFRS 1 1.000 0.000 0.320 1.000 0.000 – 0.999 0.003 0.327IFRS 2 1.005 0.361 0.892 1.013 0.016 0.073* 1.005 0.016 0.100IFRS 3 0.682 0.934 0.002*** 0.795 0.437 0.262 0.808 0.381 0.015**IFRS 4 1.000 0.005 0.305 1.000 0.000 – 0.970 0.109 0.165IFRS 5 0.996 0.031 0.209 1.000 0.000 – 1.000 0.000 –IAS 1 0.995 0.040 0.222 1.000 0.000 – 1.000 0.000 –IAS 2 0.998 0.019 0.267 1.000 0.000 – 0.999 0.005 0.327IAS 10 0.906 0.606 0.148 1.000 0.000 – 1.000 0.000 –IAS 12 1.102 0.773 0.222 0.950 0.130 0.348 1.009 0.040 0.258IAS 16 1.030 0.250 0.270 1.000 0.000 – 1.005 0.022 0.238IAS 17 1.051 0.475 0.316 1.001 0.003 0.356 1.004 0.015 0.238IAS 18 0.994 0.058 0.299 1.018 0.047 0.356 1.003 0.022 0.453IAS 19 0.996 0.151 0.808 0.993 0.021 0.381 1.046 0.133 0.083*IAS 21 1.027 0.195 0.203 1.008 0.021 0.350 1.000 0.001 0.332IAS 23 1.000 0.002 0.320 0.987 0.035 0.356 1.000 0.001 0.352IAS 27 1.000 0.003 0.181 0.999 0.003 0.356 0.996 0.024 0.441IAS 28 1.000 0.002 0.595 1.000 0.001 0.717 0.988 0.068 0.365IAS 31 0.985 0.178 0.435 0.999 0.002 0.356 1.000 0.000 –IAS 32 1.002 0.017 0.292 1.000 0.001 0.356 1.000 0.000 –IAS 36 1.003 0.038 0.504 1.000 0.000 – 1.002 0.015 0.518IAS 37 0.996 0.036 0.337 1.000 0.001 0.356 1.019 0.077 0.225IAS 38 0.925 0.574 0.226 0.999 0.003 0.946 0.979 0.119 0.357IAS 39 1.006 0.035 0.117 1.001 0.004 0.356 1.035 0.123 0.145IAS 40 0.496 3.016 0.121 1.000 0.000 – 1.000 0.000 0.327IAS 41 0.990 0.099 0.323 1.000 0.000 – 1.000 0.000 –IAS 28/IAS 31 1.000 0.000 0.188 1.000 0.003 0.356 1.000 0.000 –IAS 32/IAS 39 0.868 1.259 0.327 0.999 0.004 0.356 1.000 0.000 –IAS 27, 28 and 31 – – – – – – 0.966 0.167 0.297Goodwill 0.957 0.281 0.158 1.002 0.007 0.175 1.000 0.000 –IFRS 3 and IAS 38 1.992 0.124 0.093* 1.996 0.000 – 2.000 0.000 –IFRS 4 and IAS 39 1.000 0.003 0.508 1.000 0.000 – 1.000 0.000 –IAS 28 and IAS 21 1.000 0.003 0.320 1.000 0.000 – 1.000 0.000 –IAS 32, 39 and IFRS 4 – – – – – – 1.000 0.000 –Minority interests 1.002 0.011 0.109 1.000 0.000 – 1.000 0.000 –Reallocations 0.990 0.099 0.320 1.000 0.000 – 1.000 0.000 –Asset swaps 1.000 0.000 0.320 1.000 0.000 – 1.000 0.000 –Unclassified (other) 0.998 0.034 0.515 1.002 0.003 0.219 1.002 0.152 0.956

Notes: For each of the three sample countries, the table details the mean conservatism index value(Mean), its standard deviation (StDev) and the results from a t-test (p-value) that was used to testwhether the mean index value was significantly different from the neutral value of 1. *, ** and*** denote significance at the 10 percent, 5 percent and 1 percent levels, respectively

Table IV.Index of conservatism for

the income statement

35

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statements

UK Ireland Italy

Index Mean StDev p-value Mean StDev p-value Mean StDev p-value

Equity 1.203 1.950 0.321 0.945 0.052 0.048** 1.052 0.164 0.113

IFRS 1 0.991 0.076 0.265 1.000 0.000 – 1.000 0.001 0.327

IFRS 2 0.998 0.004 0.000*** 0.999 0.001 0.311 1.000 0.001 0.692

IFRS 3 0.820 1.552 0.269 0.978 0.035 0.179 0.969 0.065 0.019**

IFRS 4 1.000 0.003 0.320 1.000 0.000 – 1.005 0.033 0.453

IFRS 5 1.000 0.000 0.320 1.000 0.000 – 1.000 0.000 –

IAS 1 0.998 0.019 0.320 1.000 0.000 – 1.000 0.000 –

IAS 2 0.999 0.006 0.253 1.000 0.000 – 1.000 0.004 0.612

IAS 10 0.928 0.214 0.002*** 0.959 0.039 0.048* 1.000 0.000 –

IAS 12 1.031 0.139 0.037** 1.061 0.119 0.270 0.981 0.098 0.325

IAS 16 0.994 0.037 0.132 0.997 0.007 0.363 0.988 0.031 0.045**

IAS 17 1.007 0.027 0.014** 0.999 0.004 0.363 1.000 0.003 0.647

IAS 18 1.002 0.012 0.197 1.019 0.048 0.363 1.005 0.019 0.205

IAS 19 1.101 0.279 0.001*** 1.039 0.074 0.254 1.016 0.038 0.038*

IAS 20 1.000 0.000 – 1.000 0.000 – 1.000 0.000 0.327

IAS 21 1.000 0.002 0.800 1.000 0.000 – 1.000 0.000 0.229

IAS 23 0.996 0.038 0.320 0.994 0.016 0.363 0.999 0.002 0.234

IAS 27 1.000 0.001 0.230 1.002 0.005 0.363 1.002 0.013 0.361

IAS 28 1.001 0.010 0.326 1.000 0.000 – 0.998 0.018 0.551

IAS 31 1.000 0.002 0.452 1.000 0.000 0.363 1.000 0.000 0.327

IAS 32 1.001 0.007 0.420 1.000 0.000 – 1.004 0.008 0.029**

IAS 36 1.000 0.003 0.250 1.000 0.000 – 1.008 0.031 0.185

IAS 37 0.998 0.013 0.156 0.999 0.004 0.363 0.988 0.052 0.251

IAS 38 0.949 0.397 0.219 1.000 0.001 0.363 0.992 0.077 0.603

IAS 39 1.007 0.064 0.281 1.000 0.000 – 0.983 0.113 0.430

IAS 40 1.003 0.002 0.182 1.000 0.000 – 1.000 0.001 0.327

IAS 41 1.000 0.005 0.294 1.000 0.000 – 1.000 0.000 –

IAS 28/IAS 31 1.000 0.002 0.875 1.000 0.001 0.363 1.000 0.000 –

IAS 32/IAS 39 0.996 0.033 0.267 1.000 0.000 0.363 1.000 0.000 –

Goodwill 0.983 0.148 0.259 1.000 0.001 0.363 1.000 0.000 –

IFRS 3 and IAS 38 0.995 0.029 0.134 1.000 0.000 – 1.000 0.000 –

IFRS 4 and IAS 39 1.000 0.002 0.320 1.000 0.000 – 1.000 0.000 –

IFRS 3 and IAS 38 1.000 0.002 0.439 1.000 0.000 – 1.000 0.000 –

IAS 28 and IAS 21 1.000 0.001 0.320 1.000 0.000 – 1.000 0.000 –

IAS 32 and IAS 39 – – – – – – 1.006 0.046 0.496

IAS 27, 28 and 31 – – – – – – 1.001 0.001 0.084*

IAS 32, 39 and IFRS 4 – – – – – – 1.006 0.027 0.266

Prior year/Op. b/s adjustment 1.000 0.002 0.176 1.000 0.000 – 1.000 0.000 –

Opening b/s adjustment(s) 1.001 0.011 0.364 1.000 0.000 – 1.000 0.000 –

Fixed assets 1.000 0.000 0.320 1.000 0.000 – 1.000 0.000 –

Hindsight adj. 1.000 0.000 0.320 1.000 0.000 – 1.000 0.000 –

Asset swaps 1.000 0.000 0.320 1.000 0.000 – 1.000 0.000 –

Minority interests 1.000 0.000 0.320 1.002 0.004 0.363 1.000 0.000 –

Unclassified (other) 1.000 0.019 0.909 1.010 0.012 0.117 0.998 0.032 0.720

Notes: For each of the three sample countries, the table details the mean conservatism index value (Mean), itsstandard deviation (StDev) and the results from a t-test that was used to test whether the mean index valuewas significantly different from the neutral value of 1. *, ** and *** denote significance at the 10 percent,5 percent and 1 percent levels, respectively

Table V.Index of conservatismfor the balance sheet

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A similar analysis of the balance sheet adjustments to IFRS was also conducted; someof the results from this exercise are reported in Table V. In particular, thetable details the mean index value, its standard deviation and the results from at-test that was conducted to determine if the mean values were significantlydifferent from the neutral value of 1. The results are shown for the equity index and foreach partial index for each of the three sample countries. One key finding to emergefrom an examination of this table is that the impact of IFRS adjustments to nationalGAAP is not common across all three countries. For example, the effect of IFRSadjustments on UK and Italian companies was to increase total equity; on average,total equity under IFRS was 20.3 per cent and 5.2 per cent higher than under UKand Italian GAAP, respectively. By contrast, implementation of IFRS had a negativeeffect on the total equity of Irish firms; the mean index value was 0.9459,indicating that IFRS-based total equity was 94.5 per cent of its value under IrishGAAP. However, it should be noted that there was considerable variation in theimpact of IFRS on the equity of the sample companies; the standard deviation ofthe index values is sizeable at 195.0 per cent for UK firms and 16.4 per cent forItalian firms.

Table V indicates that a larger number of international standards requiredadjustment in the balance sheets of UK firms than either Irish or Italian companies,however only a few resulted in significant adjustments. More specifically, only fiveof the standards had a significant impact on the reported equity of UK firms, four hada material effect on Italian firms and only one standard resulted in a significantadjustment for Irish companies. Closer examination of these standards reveals thattheir impact was different across the sample countries. In particular, while IFRS 2(IAS 12 and IAS 19) significantly decreased (increased) the reported equity of UKfirms, it (they) had only a minimal negative (positive) effect on the balance sheet ofIrish companies and no (a mixed) effect on the net worth of Italian firms. Similarly,it was only Italian companies that recorded significantly lower (higher) equity as aresult of IFRS 3 and IAS 16 (IAS 32). However, the impact of some standards wascommon across the three countries, with IAS 10 (IAS 19) significantly decreasing(increasing) reported equity in the UK and Ireland (UK and Italy)[16].

Taken together, Tables IV and V suggest that any analysis of the impact of IFRSneeds to take account of the nationality of the company. Such a finding is notsurprising since the impact of IFRS will vary according to the differences between thenational and IASs being studied.

6. ConclusionThis paper has analysed the extent and nature of IFRS adjustments using thereconciliation statements that companies were required to produce under IFRS 1“First-time adoption of International Financial Reporting Standards”. It did so in twoways: first, by expressing the IFRS adjustment required by each standard as apercentage of the total profit (loss) adjustment in the income statement or totalequity adjustment in the balance sheet for all countries together, and second, bycalculating an index of conservatism for each country.

The results indicate that the impact of IFRS implementation on profit in each of thesample countries was significant; on average, profit calculated under national GAAPincreased by a sizeable percentage once figures were reported using IFRS. Some of thestandards responsible for this percentage increase included IFRS 3, IAS 12, IAS 17 andIAS 19. However, the positive impact of these adjustments on total profit under

37

IFRSreconciliation

statements

national GAAP was offset to some extent by changes required under IFRS 2, IFRS 5,IAS 38 and IAS 39. The results also show that the introduction of IFRS had a variableeffect on the total equity of companies from the three sample countries; while UK andItalian companies experienced an increase in equity, the Irish firms in the samplerecorded a decrease. The standards that appear to have had the largest negative effecton balance sheet figures included IAS 12 and IAS 19, although the decrease in equitywas partially offset by the positive effect of IAS 10, IAS 16, IAS 38 and IFRS 3. Perhapsnot surprisingly, some standards have no material impact on equity calculated undernational GAAP. These standards are predominantly, although not exclusively,orientated towards disclosure. While further work is required to investigate whycertain standards had the most impact, the current paper provides some direction as towhere subsequent researchers should focus their attention. In addition, the currentpaper suggests that researchers should adopt a multi-country approach whenundertaking any investigation of the impact of IFRS as standards vary in importancefrom one country to another.

Notes

1. This approach differs from existing IFRS research which can be loosely based around fivethemes: first, simulations of what might happen to company financial statements (Kasanenet al., 1992; Teodori and Veneziani, 2005); second, anecdotal evidence from the experiences ofa few early UK adopters (Accountancy Age, 2004; Financial Times, 2005b); third, consultancyreports by firms advising companies on preparation for the change (KPMG Ireland, 2003;PwC, 2004); fourth, empirical surveys of the practices or experiences of early adopters inEuropean countries (Larson and Street, 2004; Ortiz, 2005); and fifth, the empirical findings ofstudies examining the possible changes that might take place following the introduction ofIFRS (Fearnley et al., 2007).

2. The IASC often involved itself in joint projects with other accounting bodies. For example,the harmonisation process was boosted in 1987 when the IASC and the InternationalOrganization of Securities Commissions (IOSCO) joined forces to create a set of core IASs(Haller, 2002). Similarly, four of the main accounting standard-setters (the US, UK, Canadaand Australia), and the IASC also formed a separate group known as G4þ 1 to act as athink-tank based on producing transparent, capital market-based financial reports (Street,2006). It achieved a measure of success in harmonising the accounting practices of itsmembers during the 1990s and issued 12 discussion papers on matters such as recognitionand measurement, financial instruments, hedge accounting, leases and share-basedpayments (Street and Shaughnessy, 1998). The G4þ 1 gradually evolved to become an“embryonic” standard-setter but, despite these developments, progress towardsharmonisation on a wider scale was slow.

3. Before 1970, there was no formal system governing accounting standard-setting andguidance on particular accounting matters was typically provided by the professionalbodies. In the UK, accounting standards are currently issued by the Accounting StandardsBoard. As Institute of Chartered Accountants of Ireland (ICAI) is also involved in thatstandard-setting process, the resulting standards typically include a separate sectiondetailing differences for application by companies operating in the Republic of Ireland.These differences primarily relate to variations in taxation.

4. The Stock Exchange requirements contained in the listing rules are designed to regulate theflow of information in the market. These requirements must be complied with by listedcompanies; those failing to do so face expulsion from the market. Most of these requirementshave been incorporated into statute and existing accounting standards in both the UK andIreland.

38

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5. In the UK, the Companies Act 1981 reformed the form and content of published financialstatements by standardising their presentation. This legislation was amended in 1989 andhas since been replaced by the Companies Act 2006 which is more wide-ranging in nature.For example, it focuses on areas beyond the scope of traditional financial statements suchas how companies deal with social and environmental issues. Irish company law is primarilycontained in the Companies Acts 1963-1990 and the Companies (Auditing and Accounting)Act 2003 which are largely based on their UK equivalents.

6. In Italy, prudence is the basic criterion used when drawing up financial statements whereas,for the IASB, it represents only a characteristic relating to the reliability of information(Rossi, 2003).

7. The introduction of the fair value concept represents an important change in accountingtraditions for Italian companies that have tended to use historical cost (Ijiri, 1970).

8. The principle of substance over form was introduced into the Italian financial reportingenvironment in the company law reform of 2003. However, in reality, the application of thisprinciple has only ever been partial.

9. This reconciliation was required both at the date of transition to IFRS and at the end of thelatest period presented in the entity’s most recent annual financial statements under nationalGAAP.

10. It also required first-time adopters to provide an explanation of any material adjustmentsto the cashflow statement but only where one had been presented under national GAAP.Given that not all companies would have produced a cashflow statement under nationalGAAP, this part of the reconciliation was excluded from the analysis.

11. Some commentators argue that the term “conservatism index” is misleading as accountingmethods that result in lower profit or equity figures are not necessarily more conservative.Instead, they argue that the index is better viewed as a “comparability index” as it indicateshow similar or dissimilar reported figures are (Roberts et al., 2002).

12. The conservatism, or comparability, index has been used in several studies that haveexamined the differences in reported figures produced under various GAAP. For example,Weetman and Gray (1991) used the index to examine the effect of accounting principles onprofits produced under Dutch, Swedish, UK and US GAAP while Weetman and Gray (1990)and Weetman et al. (1998) studied the impact of UK and US accounting principles onreported profits. Other studies have examined the figures reported under various Europeanaccounting regimes (Emenyonu and Gray, 1992; Canib~ano and Mora, 2000).

13. To guard against the possibility that outlying index values may distort the mean results,medians were also calculated and a non-parametric Wilcoxon signed ranks test wasconducted to determine whether the median index values were significantly different fromthe neutral value of 1. Information about these median results is available from the authorsupon request.

14. In particular, IFRS 3 and IFRS 3/IAS 38 resulted in significant adjustments in reportedprofits for UK companies while IFRS 2 had a material impact on the reported profits of Irishfirms. For the Italian companies in the sample, significant adjustments in profits wererequired under IFRS 3 and IAS 19.

15. To guard against the possibility that outlying index values may distort the mean results,medians were also calculated and a non-parametric Wilcoxon signed ranks test wasconducted to determine whether the median index values were significantly different fromthe neutral value of 1. The median index values and the results from the Wilcoxon signedranks test largely confirm the findings from Table IV that first, profits reported under IFRSwere higher than those reported using national GAAP; and second, IFRS 2 and IFRS 3 had amaterial impact on the reported profits of the sample firms. However, the results also suggest

39

IFRSreconciliation

statements

that reported profits were significantly affected by IAS 10, IAS 21, IAS 39 and IAS 40 in theUK and IAS 37, IAS 38 and IAS 39 in Italy. Due to space considerations, these results are notpresented here but are available from the authors on request.

16. The results from an analysis of median index values support these findings. Specifically, inaddition to the significant standards identified in Table V, the results from the analysis ofmedian index values indicate that IFRS 3 and IAS 38 had a material effect on the reportedequity of UK firms, while IAS 37 and IAS 38 resulted in a significant adjustment to thereported equity of Italian companies.

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Corresponding authorAlison Fox can be contacted at: a.m.fox@dundee.ac.uk

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