e-sRC

CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Globalization of the world’s capital markets has brought to the forefront the increasing
need for comparable and reliable financial information to support the varied transactions and
operations of these markets. Transparency and relevance are attributes of financial reporting.
Accounting information that meets these attributes increases investors‟ confidence, leading to
enhanced capital flow. The recent financial crisis has been partly blamed on the erosion of
investors‟ confidence, owing to perceived lack of transparency in financial markets. Devalle,
Onali, and Magarini (2010) posit that opaque markets aggravate the problem of information
asymmetry between insiders and outsiders, which could impede the efficient allocation of
resources. The International Accounting Standards Board‟s (IASB) has equally acknowledged
the need to improve reporting quality globally. Consequently, the IASB promotes the application
of a common set of financial reporting standards as a solution.
Further, extant literature suggests that applying diverse accounting standards around the
world often results in the use of different criteria for resources accounting (IASB, 2009; Lorchir,
2015). Analysts view that this creates inconsistencies in the investment information employed by
global investors; a gap that is expected to be narrowed by global application of IFRS. In this
regard, complying with IFRS is expected to facilitate informed trading and reduce adverse
selection in the market. Information asymmetry puts small investors, who are less likely than
their sophisticated counterparts to generate financial information from alternative sources at a
disadvantage in the market (Ball, 2006). The notion behind the promotion of a common set of
high-quality standards globally is that the risk and cost of processing financial information to
investors is reduced.Hassan (2015) opined that in Nigeria, the information disclosure
requirements in the financial statements under Nigerian generally accepted accounting principles
(NGAAP) were grossly inadequate to effectively bridge the information asymmetry between
companies and the users of the financial statements. Shehu (2011) posit that financial
information quality in Nigeria remains weak compared too many advanced jurisdictions. This
resulted in the hampering of the growth of efficient equity markets. A common complaint among
investors in Nigeria is that financial information on company performance is either unavailable
or, if provided, lacks reliability. Hence, he conceived that companies will disclose more of their
financial information with the transition to IFRS.
The adoption of IFRS definitely affects many aspects of accounting. For instance, the
introduction of fair value principle, which is regarded as the most important implication of IFRS,
motivates more debate on the adoption of the standards. More clearly, IFRS required the use of
fair value contrary to the book value as used by Nigerian GAAP. It is believed that fair value
provides up-to-date information about assets as it reflects their real value. However, impairment
test is carried out on goodwill under IFRS, while it expected to be amortized under NGAAP.
Adeyemi (2016) is of the opinion that managers have more flexibility under IFRS and may
intend to use their accounting decisions to manipulate impairment test of goodwill which could
affect the quality of reported earnings. Likewise, NGAAP allows convertible debt to be recorded
as long-term debt, while the IFRS records convertible bonds separately into the equity
component and the debt components. IFRS which is a principle-based accounting method give
managers significant flexibility and discretion and leave more room for earnings manipulation
than rule-based accounting standards NGAAP (Adeyemi, 2016).
Furthermore, Delloite (2013) reported that the inception of IFRS has led to the use of a variety of
definitions for elements of financial statements like assets, liabilities, equity, income and
expenses. It has also resulted in the use of different criteria for the recognition and measurement
of items in the financial statements. In addition, Galaen and Stenheim (2010) recognised that the
shift to IFRS represents substantial change in recognition and measurement of accounting
numbers and it is reasonable to believe that adoption of IFRS will affect the quality of
accounting numbers. Application of the IFRS is expected to produce higher quality financial
information because the International standards are characterised by features that facilitate
reporting of quality accounting information (Barth et al, 2008).
Earning quality is defined in SFAC No.1 (2008) as earning of higher quality that provides
more information about the feature of a firm‟s financial performance that is relevant to a specific
decision made by a specific decision maker. The quality of accounting information is often
determined by the quality of the reported earnings (Schipper, 2003). Researchers use different
methods in determining the quality of reported earnings, and so, there is no universal approach
on how to determine quality of the reported earnings.Schipper and Vincent (2003) consider three
earnings quality constructs: persistence, predictive ability, and the time-series variance of
earnings as measures of earnings quality. These constructs are consistent with the Conceptual
Framework which suggests that earnings quality might be assessed by some combination of
persistence, predictive ability, and variability of earnings.
Earnings being one of the most significant economic variables in financial statements
serve as a decision base for different users of financial information. The IASB‟s campaign on the
global adoption of IFRS has recorded considerable achievements and over 120 countries have
adopted or officially allowed IFRS (PWC, 2014). Other countries are establishing timelines to
adopt the IFRS. However, the perception that adoption of IFRS is likely to increase quality in
reporting earnings and usefulness of financial statements globally has generated considerable
debate. Studies (Lorchir, 2015; Barth, & Schipper, 2008; Atwood, Drake,Myers,& Myers,2011;
Agostino, Drago, & Silipo,2011) have analysed the impact of IFRS adoption on earnings quality.
Different perspectives are followed, targeting various countries and continents.
There are two conflicting views regarding the influence of IFRS adoption on accounting
quality. Some studies show that IFRS implementation improves earnings‟ quality. In particular,
proponents such as Agostino et al, (2011); Lorchir (2015) argued that firms reporting under IFRS
provide more decision-useful accounting numbers, for investment and lending purposes relative
to firms reporting under domestic accounting standards. The decision usefulness of IFRScompliant accounting numbers from a theoretical standpoint has also been established.
Furthermore, others such as Carmone and Trombetta (2008) andBarth and Schipper(2008)
argued that the principles‟ orientation underpinning the conceptual framework of IFRS is likely
to discourage fraud.
Conversely, opponents of global application of IFRS question the notion that uniformity
of standards has significant impact on earnings quality, given that preparers‟ incentives remain
predominantly divergent and largely out of IASB‟s control (Ball et al, 2003). Others (Van der
Meulen et al. 2007; Taylor, 2009; Soderstrom & Sun, 2007; JeanJean & Stolowy, 2008) provide
empirical evidence to show that IFRS accounting numbers are not of higher quality than
Domestic accounting standards in relation to improving earnings quality (Ahmed, Neel, &
Wang, 2013). They hold the general view, that propagating an agenda for the adoption of IFRS
globally in order to improve earnings quality may be misleading. Additional explanations for the
inability of IFRS to improve earnings quality are built on the diversification of country-specific
institutional factors which potentially affect enforcement of IFRS even if they were of higher
quality. Under this line of argument, relevant research observes that the IASB would be unable
to influence institutional factors that strongly affect operational outcomes of firms within
jurisdictions (Hung &Subramanyam,2007). The World Bank‟s (2015) review of government
policies and institutions in Africa shows that half of the region‟s countries posted relatively weak
governance quality. The fact that Nigeria is adopting IFRS under relatively weak governance
quality makes Nigerian conglomerate firms a useful setting to test the effect of IFRS on earnings
quality in such jurisdictions.
Conglomerate firms in Nigeria are involved in nearly every sector of the economy as well
as every chain of production. For the Six listed conglomerates, their interests span the whole
spectrum of the economy from manufacturing to automobile, real estate, hotel, general trade and
merchandise, power, agriculture and services, among other sectors. Either within a conglomerate
or the large sectorial group, an investor will find any sector he wishes to invest in; they all have
nothing less than eight business lines that run through the entire sector of the economy (Taofik
Salako, 2013).
The general consensus in prior research is that accounting earnings are a premier source
of firm-specific information, which shows that investors rely on earnings more than on any other
summary measure of performance. Given that conglomerate firms engage in series of unrelated
business activities make them to be prone to financial and business risk which continues to erode
their earnings. Thus, earnings quality of conglomerate firms becomes paramount because of its
continued improved contribution to economic growth. It has also been found that Nigeria has
enormous prospects for investment and growth with rich deposits of natural and human
resources, which will potentially attract the interest of international investors, particularly at this
era of “Change and diversification”, economic recovery and growth plan faced by the country.
Expectedly, financial reporting quality of Nigerian firms has become an issue of interest to the
international investing community.
1.2 Statement of the Problem
Earnings could be used to tell the truth and in cheating or misleading. The difference
between true earnings and reported earnings impacts on earnings quality, which is described by
the capital markets as a summary indicator of financial reporting quality (Francis, Olsson &
Schipper 2008). Corporate scandals like Enron, WorldCom, Parmalat and, more specifically,
Afribank Nigeria PLC, Cadbury Nigeria PLC and other corporate fraud in Nigeria have
continued to raise questions about earnings quality in Nigeria and the world at large.
As the debate on the impact of global IFRS adoption continues, little is known about the
outcome in Nigeria despite IFRS adoption, creating a gap. Studies (See Ashbaugh & Pincus,
2001;Ball et al. 2003; Leuz et al. 2003; Tendeloo & Vanstraelen, 2005;Daske, 2006; Bartov,
2005; Ball, 2006; Callao et al. 2007; Hung & Subramanyam, 2007; Van der Meulen et al. 2007;
Soderstrom & Sun, 2007; JeanJean & Stolowy, 2008; Barth et al. 2008;Chen et al. 2010; Devalle
et al, 2010;Agostino et al, 2011; Christensen et al. 2015;) have continued to submit empirical
evidence supporting and refuting the capability of IFRS to enhance earnings quality. However,
until date, a consensus is yet to be reached on the efficacy of mandatory IFRS adoption impact
on earnings quality in developing countries. This realisation suggests that the debate remains
unsettled, and there is a need for further empirical evidence on different jurisdictions to enrich
the debate (Bruggemann et al. 2013). Specifically, current studies have not looked at Africa
closely in this area of accounting research, even as African countries have adopted the IFRS and
set timelines for mandatory adoption (PWC, 2014).
This study is apt given that most of the studies mentioned above were carried out in
developed countries and to the best of our knowledge there exist scanty empirical works carried
out on IFRS adoption and Quality of accounting information in Nigeria. Very few studies in this
area in Africa include the study of Elbannan (2010) from Egypt,Outa (2011) from Kenya, Ames
(2013),Yeboah and Yeboah (2015)both from South Africa and Lorchir (2015) from Nigeria.
Other Nigerianstudies have focused mainly on value relevance attributes of earnings quality and
banking sector as domain (See for example, Tanko, 2012; Akindele, 2012; Akpaka, 2014; Sanni
et al 2014; Madawaki 2014; Adaramola & Oyerinde, 2014; Abdul-Bakki et al., 2014; Adebimpe
& Ekwere, 2015; Yahaya et al., 2015; Abata, 2015;Hassan, 2015; Umoren & Enang, 2015;
Adereti & Sanni, 2016;Ogenjuwa, 2016; Olugbenga, 2016; Nnadi& Nwobu, 2016; Agir,
2017;Uwuibge et al, 2017;) ignoring other metrics of accounting quality and other sector.
The only study that covered several earnings quality measures is the study by Lorchir
(2015) focusing exclusively on eight countries in Africa.The study also incorporate 53 firmsin
Nigeria to test the impact of mandatory IFRS adoption on earnings quality. However, the
findings could not be relied upon in this domain, given that Nigeria adopted IFRS in 2012 and
the study only covers 2000-2012, unlike South Africa, Kenya and Egypt that adopted IFRS
between 1997 and 2005.
Accounting studies worldwide in line with signaling and prospect theories
preposition,have found the variable earnings management towards small positive target (SPEAR)
very important measure of earnings quality, because managers intend to signal higher quality
accounting and investor react negatively to small losses therefore managers act to avoid negative
reaction from investors by manipulating earnings upwards to avoid small losses and maintain
investors‟ confidence. However, to the best of our knowledge; no empirical studies on earnings
quality and IFRS in Nigeria used this earnings management measure.
Therefore, from the foregoing, it can be acknowledged that while studies have focused on
examining IFRS adoption and the implications on earnings quality in other countries, little is
known in Nigeria. This research gap exists even though Nigeria has already mandatorily adopted
the IFRS.
1.3 Research Questions
The study is guided by the following questions:
i. How does IFRS adoption affectearnings persistence in the listed conglomerate firms in
Nigeria?
ii. What is the effect of IFRS adoptionon earnings predictabilityof listed conglomerate firms
in Nigeria?
iii. To what extent does IFRS adoption affect earnings management towards small profits of
listed conglomerate firms in Nigeria?