e-sRC

CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The dynamic nature of the world financial market has facilitated the use of different
financial instruments that include: cash, share, loan debentures,accounts receivable or
accounts payable, financial derivatives and commodity derivatives, which include forward
contracts, futures, swaps and options (which give the buyer an option to choose whether or
not to exercise his rights under the contract). Accounting for financial instruments has
recently attracted attention, because of enormous growth in its market and equally the
exchange of traded derivatives which enjoyed a high volume of sales, especially for options
contract and financial futures. Large financial institutions that engage in the financial
instruments transactions have led to a rapid growth of the market and making it to be at the
fore front in the global financial dealings (Kirk, 2005).
As the result of harmonization of financial reporting and in deed with the aid of
globalization, cross-border transactions and trade become easy. But financial instruments
expose firms to financial, economic, and operational risks. Changes in Market conditions or
the financial position of the parties to the financial instruments or transactions expose firms
to financial and economic risks. These risks are credit risk, interest rate risk, foreign
exchange risk, market risk and liquidity risk (Hassan, Sale & Rahman, 2007)
Before the adoption of International Financial Reporting Standard (IFRS) in Nigeria, the
financial reporting and accounting practices were guided by the Statement of Accounting
Standard (SAS) issued by erstwhile Nigerian Accounting Standard Board (NASB) (Bagudo,
Abdul Manaf & Ishak, 2016).SAS 2 was about information to be disclosed in financial
statements, and it described the basis for presentation of a general purpose financial
statements, in order to ensure comparability both with the company‟s financial statements of
previous period and with the financial statements of other companies. But there is no specific
Standard in respect of disclosure requirements of financial instruments under NASB,
companies were therefore free to disclose as little or as much as they want, and in practice,
they used a wide range of disclosure methods and strategies. Moreover, most companies
recorded derivatives at historical cost, which often does not convey a true and fair picture of
the risks and rewards faced, due to the complex nature of financial instruments and the role
they played.The financial statements of a company will therefore be rendered meaningless by
the non-disclosure of a financial instruments that could have a material impact on the
Statement of Financial Position or Statement of Comprehensive Income, in some cases
turning profits into losses and net asset positions into net liability positions.
Regulatory bodies throughout the world, and the International Accounting Standards Board
(IASB) in particular have sought to introduce accounting standard to deal with Financial
Instruments disclosure in an attempt to mandate the provision of a minimum level of
Financial Instruments related information in companies‟ financial statements. Because
investigations had shown that companies were tempted not to publish information about the
extent of usage of Financial Instruments on a voluntary disclosure basis (Yasean, Theresa,
Suzanne & David, 2016).
To ensure that, financial instruments disclosure provides to the users of financial information
with the relevant and reliable information they need to make a sound decision, IFRS 7 was
originally issued in August 2005 and applies to accounting period on or before 1 January,
2007 by the International Accounting Standard Board (IASB). The fundamental objectives of
IFRS 7 requirements are to enhance users understanding of the significance of financial
instruments in an entity‟s financial position and performance, and equally to enhance
understanding the extent of the risk arising from such financial instruments to which the
entity is exposed to, during the period and at the reporting date. Therefore, accounting
framework has been shaped by IFRS to provide relevant and faithful recognition,
measurement, presentation and disclosure requirement relating to transactions and events that
are being reflected in the financial statements (Ailmen & Akande, 2012).
The demand for more information on risks has assumed monumental dimensions with the
promulgation and subsequent enhancement of the standard. IFRS 7 is applicable to financial
and non-financial entities, either an investment funds, private equity funds, real estate funds
or investment managers. The extent of disclosure required depends on the extent of the fund
use under financial instruments and its exposure to risk. The disclosure requirements are both
quantitative and qualitative. The quantitative disclosures are about the figures in the
Statement of Financial Position and Income Statement. Qualitative Disclosure on the other
hand deals with risk disclosures, this is what takes the disclosures to a new level. The risk
disclosures arising from financial instruments under IFRS 7 are given through the eyes of
management (management judgment) and should reflect the way management perceives,
measures and manages the risks involve.
Nigeria has not been left out in this historic revolution and harmonization of financial
reporting. In September, 2010 the IFRS implementation roadmap was officially announced
and the process of adopting IFRS was scheduled in three phases: publicly listed and
significant public interest entities that comprises: Banking &Insurance sub-sector, petroleum
sub-sector, telecommunications andmanufacturing firms as pioneer implementers (Ayuba,
2012; Bala, 2013; Edogbanya & Kamardin, 2014). They were mandated to prepare their
financial statements based on IFRS on or before 1st January 2012, that is full IFRS compliant
financial statements are required for accounting period to 31 December 2012, while other
public interest entities are required to adopt IFRS for statutory purposes on or before 1st
January 2013. The third phase requires Small and Medium Sized Entities (SMEs) to adopt
IFRS on or before 1st January 2014 (Ailmen & Akande, 2012). Though, this was the initial
time line, there was a subsequent deviation from the road map, but the global convergence of
IFRS and its adoption in Nigeria has witnessed a remarkable development in the annals of
financial reporting and accounting profession at large. (Andrew, 2015).
Nigeria‟s adoption of IFRS for all listed companies generated a lot of issues because the
adoption was sudden and without consultation with the relevant key stakeholders such as the
practitioners, the regulatory agencies and the academics (Edogbanya & Kamardin, 2014).
More so, because of the complexity of the standard and its disclosure requirements,
compliance with the standard after adoption were found to be low by some studies. Zango,
kamardin & Ishaq (2015) reported a compliance level of 55% and 55.5% in 2012 and 2013
respectively on financial instruments disclosure by listed deposit money banks in Nigeria.
Looking at the nature of financial instruments disclosure of IFRS 7 and by reason of the fact
that, similar standard has not been issued previously in the Nigerian SAS, it is imperative to
conduct a research to examine the level of compliance by listed manufacturing firms in
Nigeria with that disclosure requirements.
The relationship between firm characteristics and compliance with IFRS disclosure were
reviewed by previous researches (Watson, Shrives, & Marston, 2002; Eng & Mark, 2003;
Ali, Ahmed, & Henry, 2004; Fakete, Matis & Lukacs, 2008; Andrew, 2015 among others). It
has shown that levels of corporate disclosures can be explained by many factors. The
influential factors/characteristics used to proxy determinants of compliance in the studies are:
size, industry type, listing status, gearing/leverage, profitability, ownership
ispersion/concentration, auditor type, influence of audit committee and so on and so forth.
Though the results and findings of those studies are mixed, they have not reached a
consensus on the determinants that influence corporate compliance with IFRS disclosure
requirements, but at least they provided an enabling environment where other similar
researches can come up.
Profitability for instance, was found to be positively related with IFRS disclosure
requirements (Andrew, 2015), but some studies fail to find any statistical relationship with
IFRS disclosure requirements (Atanasovski, 2015). In the same vein, some studies have
found liquidity to have an adverse relationship with IFRS disclosure, and some studies found
a statistical positive relationship between liquidity and IFRS compliance disclosure (Daske,
Hail, Leuz, & Verdi, 2013; Andrew, 2015)
Company size, is seen as one of the predominant variable which most of the studies on
factors affecting IFRS compliance and corporate disclosure have used, but still the findings
are mixed. Some studies found it to be statistically and positively related (Alsaeed, 2006; AlShammari, Brown, & Tarca, 2007; Fakete, Matis & Lukacs, 2008; Andrew, 2015 among
others), while others have found size not to have any relationship with IFRS compliance
(Street & Gray, 2002; Glaum & Street, 2003; Atanasovski, 2015).
Manufacturing activities in Nigeria have significant impact on the nation‟s economy. The
sector accounts for about 10% of total GDP annually (NBS report, 2012). It could literally
assumed to have a vast potential for a spot for economic development due to abundant labour
force coupled with the agrarian nature of the economy (Ojo & Ololade, 2014). Nevertheless,
the sector faces ongoing challenges, including inadequate electricity supply, poor
infrastructure and plant maintenance, and heavy dependency on agricultural inputs, which
themselves are vulnerable to shocks. This challenges has exposed the sector to engage in the
financial instruments transactions, which involve both financial Asset, financial liability and
equity instruments. The nature of their transactions and exposure to various types of risks
like market risk, currency risk and liquidity risk will inevitably influence their compliance
level to disclosure requirements with IFRS 7 financial instruments disclosure.
Two factors motivated the study. First, it is often alleged that listed companies in emerging
economies like Nigeria are under pressure to improve their compliance level on corporate
financial reporting, as they have not fully complied with the disclosure requirements
stipulated by the regulatory agencies (Akhtaruddin, 2005). Second, the regulatory bodies and
the accountancy profession of emerging nations do often take a lenient attitude towards
default of accounting regulations, as such compliance might be low (Ali, Ahmed & Henry,
2004).
1.2 Statement of the Problem
Information disclosure can be seen as a strategic tool that facilitate company‟s ability to raise
capital either through issue of shares or debt, on long term or short term basis, at the lowest
cost possible (Healy & Palepu, 1993). IFRS 7 requires the disclosure of information about
significance of financial instruments to an entity‟s financial position and performance and
extent of risks arising from those financial instruments, both in quality and quantity. The
standard has added certain new disclosures about financial instruments to those already
required by International Accounting Standard 32 (IAS 32), it also replaces the disclosures
previously required by IAS 30, and then put all those financial instruments disclosures
altogether into a new standard, that is IFRS 7. In Nigerian context however, with the
announcement of the federal government intention to adopt IFRS with effect from 1st
January, 2012, listed entities were mandated to comply with the disclosure requirements of
the standard.
Evidence from empirical studies on the relationship between firm characteristics and
compliance with IFRS 7 financial instruments disclosure requirements is quite mixed, and
the findings have varied, and makes it inconclusive. Results/findings from empirical studies
in the relationship between profitability and financial instruments disclosure varies,some
studies reported a positive relationship (Andrew, 2015), and some studies reported a negative
relationship (Atanasovski, 2015). Tsegba, Semberfan and Tyokoso, (2017) evaluate firm
characteristics and IFRS compliance, The study used profitability in determining IFRS
compliance by listed financial service companies, because of the peculiar nature of the
sector, the study cannot be generalized on other subsectors. A research in that respect is
important.
Financial instruments disclosure and liquidity on the other hand have shown a mixed
findings, some studies have found liquidity to be negatively related to IFRS disclosure, and
other studies on the other hand found a statistical positive relationship between liquidity and
IFRS compliance disclosure (Daske, Hail, Leuz, & Verdi, 2013; Andrew, 2015). But in the
Nigerian context, and to the author‟s best knowledge, no empirical studies that included
Liquidity in assessing its relationship with the financial instruments disclosure of IFRS 7.
Therefore, considering how liquidity is important in determining the extent of a firm‟s ability
to settle obligations as at when due, a study that will include such variable is imperative in
Nigeria.
Company size and leverage are two known variables that were used by most of the studies on
factors affecting IFRS compliance, but still the findings are mixed. Some studied found them
to be statistically and positively related (Al-shammari et al 2007; Fakete, Matis & Lukacs,
2008; Bamber, 2011; Andrew, 2015 among others), while others have found no any
empirical relationship with IFRS compliance (Street & Gray, 2002; Glaum & Street, 2003;
Atanasovski, 2015). But most of the studies are Asian and European based studies, and some
are overtaken by events.
With regards to financial instruments and auditor type, the IASB and other researchers were
of the view that the non-compliance with the standard as the result of an external auditors‟
inability to detect the non-compliance (detection risk), most of the companies‟ disclosure
were not absolute (Glaum & Strret, 2003; Street and Gray, 2001; IASB, 2005). The
derivatives losses has also been cited by Daske, Hail, Leuz & Verdi, (2008), who categorize
IFRS compliant companies as serious adopters and label adopters, as this is a clear case of
non-compliance.
Furthermore, there is also a contextual gap in the area of research on the factors that
influence compliance with IFRS 7 disclosure in Nigeria. Most of the Nigerian studies are
examining the compliance level with IFRS 7 with few of them evaluating those factors that
influence compliance with IFRS in general, there is need for those studies that will assess
different standards, like what this research have evaluated.
From the foregoing, we can deduce that, the results from the various studies into the
relationship between determinants of compliance with IFRS 7 disclosure requirements are
inconclusive and a further study is imperative. Therefore this study will examine the effect of
firm characteristics on compliance with financial instruments disclosure requirements of
IFRS 7 by listed manufacturing firms in Nigeria.
The researcher is therefore motivated by the above gaps in financial instruments disclosure
research, and make an attempt to provide an empirical support between firm characteristics
and compliance with IFRS 7 financial instruments disclosure requirements by listed
manufacturing firms in Nigeria.
1.3 Research Questions
In an attempt to provide research questions for the study, the researcher seek to provide
answers to the following questions:
i. Does profitability affects compliance with IFRS 7 financial instruments
disclosure requirements by listed manufacturing firms in Nigeria?
ii. To what extent does liquidity affects compliance with IFRS 7 financial
instruments disclosure requirements by listed manufacturing firms in Nigeria?
iii. What is the effect of auditor type in compliance with IFRS 7 financial instruments
disclosure requirements by listed manufacturing firms in Nigeria?
iv. What is the effect of leverage in compliance with IFRS 7 financial instruments
disclosure requirements by listed manufacturing firms in Nigeria?
v. To what extent does firm size affects compliance with IFRS 7 financial
instruments disclosure requirements by listed manufacturing firms in Nigeria?