e-sRC

CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Accounting standards have changed greatly over the past decades with regard to the consistently
increasing emphasis placed on measurement of assets base on fair valuation and pressing need
for harmonization. However, in order to address the need of various users of financial
information, locally formulated standards limit the ability to undertake cross boarder
comparison. Therefore, the need for harmonizing of global financial accounting increased. The
journey for the international harmonization toward a unique and global set of accounting
standards started in 1973 when 16 professional accounting bodies agree to form the International
Accounting Standard Committee (IASC).
The rationale behind the formation of the Committee was to produce and issue the International
Accounting Standards (IAS) which came out of necessity to encourage growth in trade and
investment between countries around the globe. The Committee was reorganized in 2001 to
become International accounting Standard Board (IASB) which develops and issues International
Financial Reporting Standards (IFRSs). Consensus has been reached that quality of accounting
reporting is paramount to the information users for various decisions making purposes. IFRSs are
increasingly becoming more acceptable set of regulations followed by many countries. In an
effort to increase comparability, European Union mandated the adoption of IFRS to all its public
entities in 2005. It is reported that more than 130 countries conformed to IFRSs as domestic
reporting standards with 90 countries fully adopted (PWC, 2016).
Prior to international financial reporting standards, different countries develop their own
standards locally and also to a certain extent adopt or adapt that of the other countries. In
Nigeria, National Accounting Standard Board (NASB) develop and issue Statements of
Accounting Standards (SAS) which are popularly known as Generally Accepted Accounting
Principles (GAAP). These standards cut across various aspect of accounting activities such as
recognition, measurements, and reporting of accounting transactions of various form of business
activities. Therefore, SAS play a vital role in regulating the activities of accounting locallydue to
the fact that financial reporting practicebefore IFRS depend on legal, economic, cultural and
historical background of any country.
However, the major concern about the GAAP in several countries is that they are designed to
reflect specific countries accounting needs, taken in to consideration different countries‟
regulatory and legal framework. Therefore, the need for globalization and growth of businesses
brought difficulties in comparability and understandability of the local standards internationally.
Also, the need to attract funds from the investors, creditors and financial institutions externally
ignite the idea of accepting a common language for financial reporting in Nigeria so as to
encourage international comparability. These and other issues pave the way toward
harmonization of accounting standards and necessitate the need for a single set of high quality
internationally generally accepted accounting standards (Ocansey, and Enahoro, 2014).
It is expected that adoption of IFRS would result in high quality reporting practice in Nigeria
(Abiodun, 2012). The adoption of IFRS in Nigeria will lower the cost of capital and improve
market liquidity (Leuz&Verrecchiia, 2010). Furthermore, IFRS adoption may encourage
comparability and lower the cost of producing multiple financial reports to cater the need of
cross-border investors in Nigeria (Okere, 2009). Similarly, the demands for functional financial
institutions that would facilitate the development of stock market also encourage harmonization
of financial reporting system. Financial sector is a driving sector of the economy; it contributes
tremendously to the overall growth and development of stock markets (Mohammed & Lode,
2015).
Report on the Observance of Standard Codes (ROSC) in 2011 states that financial institutions in
Nigeria do not provide full disclosure of accounting information as stipulated by the standards in
their financial reports which was attributed to downturn in the Nigeria stock market and serve as
a remote cause of the crises in the sector. As a result of this report and other reasons mentioned
earlier, Nigerian government started IFRS adoption process by signing in to law, Financial
Reporting Council (FRC) Act 2011 to replace the NASB Act 2004.
Jafaar (2011) reported that functional capital market depends on high quality information (book
values, earnings, liquidity, other comprehensive income) to survive. Investors and accounting
standards setters also require such information too. The primary characteristics of accounting
information are relevance and reliability (now representational faithfulness). Value relevant
information is the information that has the capacity to influence user‟s decision making (Barth
Beaver & Landsman, 2001).
Similarly, differences exist between GAAP based system and fair value system in respect of the
recognition and valuation of assets and liabilities. These differences distort the statement of
financial position through the book-values (shareholders‟ funds). Book value is an important
variable which affect the market value of equity share. It is the value of the financial service
firms‟ funds. The book value tells us the worth of each share in a financial service firm and helps
in fundamental analysis of shares. Book value shows worth of shareholders stake in a firm, it
includes share capital and reserves. The book value reflects the past earnings and dividend
distribution. A high book value indicates huge reserves and bonus to the shareholders. Book
value affects both investment decisions and dividend decisions of a financial service firms and
both investment and dividend decisions affect the share prices.
IFRS adoption most likely results in reduction of information asymmetry between investors and
management due to the increased disclosure of financial information (Jafaar, 2011). Also, the
adoption of IFRS showcase a significant changes in bank loan loss accounting in Nigeria as
regard the recognition and measurement of credit risk. International Accounting Standard (39)
requires bank to make a provision for only incurred losses. While Nigeria GAAP suggests that a
provision should be made for even future expected losses. Considering the importance of loan
loss provision in determining the reported earnings and discretionary tendencies that the reported
provisions may generate, earnings reported under IFRS may defer from that of the GAAP of the
financial service firms in Nigeria. Furthermore, income as an important variable, which is the
change in purchasing power possessed by the entity between two points in time, provides
indications of the earning power and future cash flows of financial service firms. The value and
usefulness of income numbers is significantly different under the GAAP and fair value
accounting period which potentially affect the users‟ decisions.
Opinions are divided regarding the accounting of intangible assets (goodwill and Identifiable
intangible assets) during the globalization of accounting standards (Chalmers, Clinch &Godfray,
2008). The controversy is centered on capitalization, amortization, and impairment among
others. Adoption of IFRS in Nigeria in 2012 have change the recognition measurement and
reporting procedures for intangible assets of financial service firms in Nigeria. Intangible assets
according to International Accounting Standard on Intangibles (IAS 38) are identifiable nonmonetary assets without physical substance, such as computer software, patents, and copyrights.
Lev (2001) opined that intangibles are created through innovation, unique organizational designs
or human resource practices, and they interact with tangible and financial assets to create value.
It is therefore believe that intangibles are sources of probable economic profits, lacking physical
substance and controlled by the firm due to previous events or transactions (Canibano, Covarsi&
Sanchez, 1999).
The increasing choice to capitalized intangible assets provides an important mechanism for
manager in supplying private information to the investors in order to minimize the problem of
information asymmetry which consequently maximizes the value of the firm in line with
efficient market hypotheses and signaling theory. In essence, choice in capitalizing intangible
assets is like spreading strong insider information about the quality and achievement of the firm
to the public which would in turn enhance investor‟s confidence and belief about the future cash
flow of that organization and consequently reflect on their share price. This implies that
capitalizing intangible assets impacted on the market value of equity (Chalmers, Clinch &
Godfrey, 2008; Istrate, 2013).
Several studies have examined the value relevance of book values, earnings, intangible assets,
cash flow among others. These studies reported that book values and earnings contain value
relevant information (Bagudo, Abdulmanaf&Ishak, 2015; Bolibok, 2014, Barth,
Landsman&Lang, 2008). While some of the studies posit that intangible assets capitalized have a
significant impact on share prices (Jaafar, 2011; Tsoligkas&Tsalavoutas, 2011). Therefore, it is
imperative to investigate whether adoption of IFRS is still meeting the stated expectations of
relevance and comparability.
1.2 Statement of the Problem
The purpose of accounting information to stakeholders is to provide information about the entire
aspect of their investment. Useful and timely information is needed about the assets, liabilities,
equity, revenue, profits or losses, cash flows, stakeholders, strength and weakness of the
business. Potential and existing investors rely on accounting information in their pricing of
shares and take a decision on whether to have a stake in the business or not. Proponents of fair
value accounting (mark-to-market) such as Veron (2008) and Barth (2006) argue that historical
cost accounting (which is the measurement procedure during SAS regime) lack relevance as the
information produced by the historical cost model do not reflect market situations and hence, is
irrelevant for decision and even misguiding. In a Stock market like any other market, prices are
determined by the forces of demand and supply. In line with the argument of Malkiel&Fama,
(1970), any company that supplied relevant information needed by investors may likely have the
lead and undue advantage over the others.
Additionally, the ROSC (2011) report concluded that regulatory institutions and enforcement of
accounting standard is weak and ineffective in Nigeria and consequences of the weak and
inefficient environment lead to an insider‟s abuse. In an effort to address these challenges,
federal government of Nigeria in 2011, kick started the process of establishing FRC in 2012,
announce the mandatory adoption of IFRS. The expectation is that, the new accounting regime
(IFRS) may improve the quality and relevance of accounting information (book value of equity
and earnings)
The debate on the link between book value and market value is equally inexhaustible. It has been
a subject of intense divergent views even before the adoption of IFRS. Several studies have
reported mixed reactions on the impact of book values on share price. Most of these studies
observed only one period (Hunt &Shevlin, 1997: Bao, & Chow, 1999). That is, either the pre
adoption of IFRS or post adoption period. It is equally important to examine the value relevance
by studying the two periods together to see which one is better off or worse off.
Although earnings play a very important role in the valuation process, relevant earnings
information can be considered as an informant that explain the market value and relevant tool in
evaluating firm’s ability to generate future earnings. There is possible tendency that the earnings
would improve over time as a result of capitalization of more intangible asset during IFRS
regime. However, in determining future earnings, linking the earnings and share price is never
being out of place. Hence, this study is set to examine earnings and share price of listed financial
service firms in Nigeria.
Before the adoption of IFRSs, investors have witnessed challenges of comparability of financial
information due to largely diverse choice of valuations and reporting. The choices are either to
capitalize or to expense the assets. Capitalizing intangible assets may result in improving the
information contents of financial statement which as a result may likely influence its share
prices. Also expensing the said assets may result in understating profits. Therefore, with the
mandatory adoption of IFRS, there is high expectation and hope for comparability and this may
attract foreign direct investments. Thus, the absent of intangible assets in the financial statement
render it less informative on current financial position as opined by (Abubakar&Abubakar,
2015). These further added to the increasing gap between market value and book value of equity
which serve as an indicator of loss of relevance. Hence, this study examines the effect of
capitalized intangible assets on the share of listed financial service firms in Nigeria.
Similarly, the items that are previously classified as identifiable intangible assets in business
combination under the previous GAAP are required to be reclassified as goodwill under IFRS 3
(2008). This is due to the fact that the goodwill asset does not meet the definition of intangible
assets as prescribed by IAS 38. Also, under IFRS, intangible assets can be measured at cost or
revalued, while the Nigerian GAAP (SAS) suggested such assets to be measured at cost only.
Considering the aforementioned, it is imperative to exploit these differences reported under the
two regimes in order to assess their effects on market value. In other word, to establish how the
various components of intangible reflect in the share price of a firm. By implication may contain
some useful information that will influence the decision making of the users of financial
information.
Previous studies have been carried out in different parts of the world to address the relationship
between value relevance of IFRS and share price of listed financial service firms by different
economy. These include that of United State of America (Barth, Landsman & Lang, 2008; Ding,
Hope, Jeanjean&Stolowy, 2007); China (Elshadidy, 2014; Liu, Yao, Hu &Liu, 2011); Germany
(Bartov, Goldberg & Kim, 2005; Hung, &Subramanyam, 2007);
UnitedKindom(Tsoligkas&Tsalavoutas, 2011,); South Africa (Ames, 2013) and Nigeria
(Bagudo, Abdulmanaf&Ishak, 2015) among others. Mixed findings have been reported and few
of these studies explored the Nigerian perspective. Considering the differences of economic
transformation, changes in macroeconomic index and level of technological advancement,
findings of this study may be of great importance. Furthermore, time variant is another gap the
study addresses as most of the studies did not cover recent period while this study is expected to
extend to 2015.