Does The IFRS 15 Impact Earnings Management? Initial .
Vol. 13(7), pp. 226-238, 14 April, 2019DOI: 10.5897/AJBM2018.8735Article Number: 54E2E2F60579ISSN: 1993-8233Copyright 2019Author(s) retain the copyright of this articlehttp://www.academicjournals.org/AJBMAfrican Journal of Business ManagementFull Length Research PaperDoes the IFRS 15 impact earnings management? Initialevidence from Italian listed companiesMarco Tutino1, Carlo Regoliosi1, Giorgia Mattei1*, Niccolò Paoloni2 and Marco Pompili11Department of Business Studies, School of Economics and Business Studies Roma Tre University, Rome, Italy.2Department of Engineering, Roma Tre University, Rome, Italy.Received 18 December, 2018; Accepted 27 February, 2019The purpose of the present work was to gauge the extent of the impact on earnings managementderived from the adoption of International Financial Reporting Standards (IFRS) 15 as well as detectingwhether the impact will be similar in different industries. To provide empirical evidence that earningsmanagement is more frequent in some industries and less frequent in others by means of a statisticalanalysis, a sample of Italian listed companies in the period 2001-2017 was observed. Specifically,companies belonging to two sectors were selected: “Telecommunications” and “Utilities”. The JonesModel was applied. The statistical analysis brought to light that earnings management practices are“commonly adopted” in the “Telecommunications” industry, which is consequently highly impacted bythe introduction of IFRS 15. That being said, the lesson learned from this study is that theimplementation of the new principle, written to discipline the accountancy of revenues, and itsconsequences, must be carefully analyzed and monitored by the regulators, as well as correctlyadopted by managers, as the determined revenues could have an impact on the pre-existing earningmanagement practices. The scientific contribution of the present research also concerns thepredictions on the behavior of managers that can be foreseen considering the agency theory; therefore,knowing ex-ante in which industries earnings management has a high impact, provides the option toforesee the hypothetical moves of the managers in the implementation of IFRS 15.Key words: earnings management, discretionary accruals, IFRS 15, telecommunications, utilities.INTRODUCTIONSince 1973, there has been a worldwide trend tostandardize the accounting principles. Over the last fewyears, the need to harmonize accounting rules has risenin Europe too. As a result, the European Commissionstarted issuing directives to the member states. Theobjective of the European Union (EU) is to facilitate thedevelopment and efficiency of European financialmarkets. The application of different accounting standardsin each Member State has, in fact, in the past determineda low degree of comparability of financial reportingamong companies located in different European States,constituting a deterrent in the development of thesemarkets. The European accounting legislation (that isDirectives n. IV and VII, respectively on the subject of the*Corresponding author. E-mail: giorgia.mattei@uniroma3.it.Author(s) agree that this article remain permanently open access under the terms of the Creative Commons AttributionLicense 4.0 International License
Tutino et al.annual financial statements and consolidated financialstatements), which is applied differently in each memberState, was no longer adequate to ensure this objective.In this regard, the European Union Parliament decidedto promote, and progressively to make mandatory, for thefiscal years starting after 1 January 2005, the adoption rated by the International Accounting StandardsCommittee (IASC) – initially by a group of professionalaccountants, and subsequently by a board calledInternational Accounting Standards Board (IASB), whichis an internal committee of the global organization foraccountancy (International Federation of Accountants –IFAC).The European Union decided to focus its attention onIAS/IFRS as an answer to its previously set ideas, suchas (Preface to IFRS, 2018):1. “develop [.] high quality, understandable andenforceable global accounting standards [.], that requirehigh quality, transparent and comparable information [.]to help participants in the world's capital markets andother users [.]”;2. “promote the use and rigorous application of thosestandards”;3. “bring about convergence [.]”.These are also the reasons why IAS/IFRS achievedsuch an extraordinary success persuading almost 100Countries to adopt them (Ball, 2006).Moreover, many studies showed that adopting IFRS,firms act optimally and promote financial reporting qualityand investor interests (Fields et al., 2001). Otherresearches, some with empirical evidence, show that theadoption of the IFRS reduces the level of earningsmanagement (Rudra and Bhattacharjee, 2011; Cai et al.,2008) since this set of standards limits the management‟sopportunistic discretion (Barth et al., 2008) and,consequently, the adoption of IFRS decreases the use ofdiscretionary accruals (Guenther et al., 2009).In this scenario, the current, major change in theIAS/IFRS‟ panorama is represented by the adoption oftwo new standards as IFRS 9 “Financial instruments” andIFRS 15, titled “Revenue from contracts with customers”.stThese standards have become mandatory from the 1January 2018. The present work focuses on IFRS 15,because, it can be considered one of the crucial issuesfor companies, considering that revenues are both easilyexamined and one of the primary earnings subject todiscretion (Stubben, 2010).The aim of the present work was to evaluate the impactof IFRS 15 on earnings management and questionwhether the level of impact will be different according tothe industrial sector of the entities.In the past, the Big-Four companies (KPMG, Ernst andYoung, Deloitte and PricewaterhouseCoopers) havehypothesized that a different level of impact of IFRS 15227could exist considering specific features of the industries,which directly influence the revenues, however theimpact of this on earnings management remainsunverified.Therefore it seemed useful to provide empiricalevidence in specific industries where earningsmanagement is more frequent, followed by an attempt toevaluate the benefit obtained from the correct andadequate introduction of the IFRS 15. The paper isstructured as follows. The next section reviews academicliterature on the impact of IAS/IFRS adoption on earningsmanagement and its possible future effects withindifferent industries. The following section is dedicated toexplaining the empirical research; in detail, thebackground research is presented, such as the literatureand information necessary to create the basis for theresearch, the methodology used for the analysis isdescribed, the variables, the sample and the regressionused as well as the findings and an initial discussionabout the results. The paper ends by reporting the mainconclusions and explaining the limitations.LITERATURE REVIEWThe adoption of accrual-based accounting is considerednecessary because it is able to provide a completepicture of the financial transactions of the business,recording all period transactions. The system, beingbased on a complete record of the financial matter,discloses correct profit or loss for a specific period; aboveall when compared to a cash-based system, in whichtransactions are recorded only when cash is received orpaid, accrual accounting could be considered lessvulnerable in a real management practices perspectivesince monetary flows systems are easier to manage. Thisis one of the reasons why IFRS are based on accrualaccounting.The latter point is widely agreed upon in the mainliterature. Goldman and Brashares (1991) believe that ency of financial statements and allows a faithfulrepresentation of corporate performance; similarly,Vinnari and Näsi (2008), argue that the adoption ofaccrued-based system, such as the IAS/IFRS system, isable to limit the use of creative accounting. The term“creative accounting” refers to the use of the flexibility inaccounting principles in order to manipulate thepresentation and/or valuation of financial statement items(Jameson, 1988). Consequently, budget editors canshow stakeholders whatever they find more convenient,hiding the company‟s actual performance. Given thatsuch practices rely on the interpretation of accountingprinciples, it remains very difficult to establish when theyare bound to illegality (Amat et al., 1998).Considering that IFRS are standards elaborated on an
228Afr. J. Bus. Manage.accrual basis, the adoption of these principles is widelysupported by mainstream literature, even though eachauthor provides a different reason, i.e. Corsi and Mancini(2010) highlight its superiority over, for example, theGenerally Accepted Accounting Principles (GAAP), whichare not “rigorous” enough, leaving high degrees offreedom in implementing earnings management policies.Jeanjean and Stolowy (2008) assert that implementingIFRS simplifies the comparison of companies‟ financialperformance across different countries.Focusing on earnings management has brought to lightthe ongoing debate in literature started in 1980, whenmany authors started developing models to highlight thepersistence of the phenomenon (Healy, 1985; De Angelo,1986; Jones, 1991; Dechow et al., 1995; Dechow andDichev, 2002; Tutino and Pompili, 2017). Two mainearnings management categories can be identified:1) Accruals management, related to the possibilitiesoffered by the accounting standards (professionaljudgments), aiming at “obscuring” or “masking” trueeconomic performance (Dechow and Skinner 2000),2) Real activities manipulation, occurring when managersundertake actions that change the timing or structuring ofan operation, investment, and/or financing transaction inan effort to influence the output of the accounting system(Gunny, 2010).By relating the IAS/IFRS and the earningsmanagement some authors have realized that the qualitythat would place IAS/IFRS above local GAAP is thereduction in costs for investors to assess the quality ofthe information reported in IFRS compliant financialstatements. In fact, the greater comparability of thefinancial statements would make it possible to identifyany earnings management action in a timely manner,reducing the possibility of opportunistic behavior bymanagers. Mechelli and Cimoni (2012) highlight theability of the IAS/IFRS to fill in local legislative gapsrelating to particular events that must be reported in thefinancial statements. For example, the presence of “gaps”in enforcement mechanisms could weaken, or evennullify, the positive effects of the new standards.Other authors such as Leuz and Verrecchia (1999),Ashbaugh and Pincus (2001), Leuz (2003) pointed outthat the greater disclosure required applying the IFRS forthe financial statements preparation would result inreduction of opportunistic behavior.Nevertheless, different and conflicting conclusionsresulted in many investigations carried out in this specificfield.Barth et al. (2008), observing the quality of “budgetnumbers” before and after the adoption of IFRS on asample of 327 companies that opted for voluntaryimplementation between 1994 and 2003, a lowerearnings management was found, along with a greatervalue relevance and a timelier recognition of lossesfollowing the introduction of international accountingstandards, translating into higher quality financialstatements than those prepared with local GAAP. Daskeet al. (2008), examining the economic consequences ofadopting IFRS on a sample of 3.800 first-time adopters in26 different countries, found a positive correlationbetween the introduction of IFRS, market liquidity and themarket valuation. Differently, Armstrong et al. (2010)analyzed the potential impact on stock market price withthe adoption of IFRS. The results showed a positivecorrelation underlying a positive (negative) marketreaction with the increase (decrease) in the probability ofIFRS adoption. The combination of these results showsthat, at least for early adopters, companies could benefitfrom the adoption of IFRS. Iatridis (2010) drew similarconclusions observing a sample of listed companies inthe UK: the adoption of IFRS is able to reduce thepossibilities of earnings management as it leads to atimelier and value relevant recognition of losses.While with the exact opposite idea, Capkun et al.(2016), showed that early adopters of IFRS hadincentives to increase the transparency of their reportingin order to attract outside capital, and, therefore, earningsmanagement (smoothing) went down after voluntaryIFRS adoption, while those firms that waited until IFRSreporting became mandatory in EU countries lackedincentives for transparent reporting, leading to increasesin earnings management (smoothing) after mandatoryIFRS adoption. Meaning that IAS/IFRS standards thatwent into effect in 2005, permit greater flexibility inapplication and thus contribute to greater earningsmanagement. A similar conclusion can also be found inUgrin et al. (2017) where the authors demonstrated that auniform association between IFRS adoption and earningsmanagement across countries does not exist, in factsometimes, IFRS create an environment that allows forfinancial manipulation. Similarly, another contributionelaborated by Ewert and Wagenhofer (2005) found asignificant increase in income-increasing earningsmanagement after IFRS adoption amongst firms based incountries that are more power distant, uncertaintyavoidant, individualistic, short-term oriented, andindulgent.Therefore, from a theoretical point of view, there are nodoubts about the benefits of the IAS/IFRS adoption.Following the same path of the literature, an attemptwas made to find any evidence on the potential differentimpact of IAS/IFRS observing different industries (Daskeet al., 2013; Munter, 2016). The rationale for theinvestigation emerges following the mandatory adoption,starting from 1 January 2018, of a specific accountingstandard related to the revenue components valuation:IFRS 15.The impact of the adoption of this new IFRS may havea significant effect on the financial statements of manyentities as the amount of revenues and contract costs
Tutino et al.229Table 1. IFRS 15 and Impact on Financial Statement Quality: The “Big-Four” Expectations.SectorInsuranceBuilding and constructionRetail and consumer goodsLicensors*Real estateTechnologyTelecommunicationEnergy (mining, oil and MediumMediumMediumHighHighLowLowa) KPMG (2016, May), “Revenue - Issues in depth”, available at www.kpmg.com.b) Ernst and Young (2016, April), “Revenue from contracts with customers, A summary of IFRS 15 and its effects”, available atwww.ey.com.c) In this case the papers of each sector were analyzed and the relative judgment was taken from the analysis of each. Thekey element to arrive at the aforesaid judgment was the level of risk of error associated with the steps of the IFRS 15 model.d) PriceWaterhouseCoopers (2014, June), “IFRS 15: implementation challenges”, available at from www.pwc.com.* media, life science, franchisors.and/or the timing of their recognition may differsignificantly from current practice. The application of thenew standard will have effects on all IFRS adopterentities and on the most significant item of their financialstatements that is revenues.To understand whether the impact of this newprinciples will be the same on all industries, the specificsectors guide lines was used, which is available on theweb sites of the Big-Four.Table 1 summarizes what has been analyzed. Inparticular, the opinions provided by the “Big-Four” areconsistent, with the exception of specific industries like“Technology” and “Energy”. The Telecommunicationssector is the most affected, while an average impact isexpected for the other sectors.Referring to the North American Industry ClassificationSystem (NAICS) used in this work (NAICS is thestandard used by Federal statistical agencies inclassifying business establishments for the purpose ofcollecting, analyzing, and publishing statistical data), theEnergy sector can be considered as a subsector of theUtilities sector. Which, in fact, is made up of companiesoperating in the following areas (i) electric bulk powertransmission and control; (ii) fossil fuel electric powergeneration; (iii) natural gas distribution; (iv) other electricpower generation (Table 1).In this regard, several studies have been conducted onthe “Insurance” and “Banking” industries (Firoz et al.,2011; Agostino et al., 2011; Post et al., 2007; Helfensteinet al., 2004; Bischof, 2009); other studies analyzed thecompanies in the “Manufacturing” industry (Colwyn andLuther, 2005). Currently few researches are focused onthe impact of the adoption of IAS/IFRS on earningsmanagement in the “Telecommunications” and “Utilities”industries.EMPIRICAL RESEARCHBackgroundAs previously stated, this paper proposes a comparative analysisaimed at highlighting the amount of discretionary accruals presentin two different industries with a different degree of sensitivity to theapplication of IFRS 15: “Telecommunications” and “Utilities”.The objective of the analysis is to understand whether theapplication of IAS/IFRS could increase the quality of accountinginformation and decrease the earnings management policies. In thisregard the Agency Theory approach must be considered (Jensenand Meckling, 1976) in accordance with the shareholders need todelegate the management considering specific skills andknowledge (Zanobio, 2012), showing that the Agency Theorymakes several predictions regarding the managers of behavior(Iatridis, 2010).The need for this analysis arose observing the numerouschanges made over the last few years by the international standardsetters aimed at improving the set of accounting standards whosecontinuous process of updating has led to the introduction of theIFRS 15. The new accounting principle provides rules for revenuesrecognition that are profoundly different from the ones provided bythe IAS 18, regarding the definition of revenues‟ amount, contractcosts and the timing of their recognition.The application of the new standard will have significant effectson the financial statement of entities adopting IFRS (Ballarin, 2017),but not limited to the revenues items. The following analysis will beexplained, being based on the earnings management modelproposed by Jones (1991), it aims at identifying the status ofItalian listed companies, until 2017. The analysis, concurrently withthe analysis of the “Big-Four”, compares the Telecommunicationand Utilities industries, respectively identified as a high sensitiveand a medium/low sensitive industry to the introduction of the newIFRS 15.The statistical activity focuses on the analysis of the context ofthe application of the new IFRS 15, considering that revenues,albeit not considered as subject to manipulation are subordinate tothe new principle, and play a fundamental role with regard toearnings management practices, as a proxy for the measurement ofthe conditions of the companies.
230Afr. J. Bus. Manage.Establishing the introduction of IFRS 15 and the potential impact onearnings management opportunities can provide indications to alarge number of stakeholders (such as shareholders, policy makers,auditors, etc.) providing them with indications of manipulation in thefinancial statements of specific industries.MethodologyAccrual ModelThe discretionary share of total accruals has been used in order toidentify a proxy to take earnings management into account. In fact,the “accruals management” analysis perspective has been adoptedin this paper.The Jones Model (Jones, 1991) has be
of IFRS 15 on earnings management and question whether the level of impact will be different according to the industrial sector of the entities. In the past, the Big-Four companies (KPMG, Ernst and Young, Deloitte and PricewaterhouseCoopers) have hypothesized that
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