The purpose of this study is to examine the effects of adopting International Financial Reporting Standards (IFRS) on financial statements of the largest Canadian firms (S&P/TSX 60) listed on the Toronto Stock Exchange (TSX).
This study investigates the financial statement effects of 46 companies from the S&P/TSX 60 index which report under IFRS in 2011 and switched to IFRS from CGAAP. This study used panel data analysis, which can be considered as more powerful when conducting cross-sectional and in time analysis among companies. Because of weakness of Cramer statistic on R-square, the authors used interaction terms as suggested by Hope (2007).
Consistent with the authors’ perceptions, this study finds that significant effects of adopting IFRS are associated with industry practices. The empirical results show that the adoption of IFRS in Canada created more relevant financial reporting for book value of equity and net income in the post-adoption periods.
This study should be of interest to the US regulators considering IFRS adoption by US publicly traded companies as well as to regulators, standard setters and listed companies in all countries worldwide that are in transition to IFRS.
Jermakowicz, E., Chen, C. and Donker, H. (2018), "Financial statement effects of adopting IFRS: the Canadian experience", International Journal of Accounting & Information Management, Vol. 26 No. 4, pp. 466-491. https://doi.org/10.1108/IJAIM-08-2017-0096Download as .RIS
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The widespread acceptance of International Financial Reporting Standards (IFRS) has been remarked upon and studied at great length, and many investigations have confirmed, in general, that IFRS adoption does result in more meaningful financial reporting, as evaluated, variously, by improved transparency and higher quality reporting, with the latter commonly being gauged by the relevance of equity book value and earnings for company share prices.
Prior studies suggesting the beneficent consequences of IFRS adoption have, of necessity, contrasted reporting under pre-change regimes that were significantly at variance with IFRS, often because those were regimes established under code-law legal frameworks (Christensen et al., 2007; Barth et al., 2008). Those frequently featured requirements were designed to provide strong creditor protections, but were less pertinent to the concerns of owner-shareholders, as are those financial reporting systems that evolved in common law settings. The current study attempts to correct this unavoidable bias by examining the impact of IFRS adoption by large Canadian public companies, which was mandated effective 2011, and which might more reliably presage the effects of voluntary or mandatory adoption by US public companies, were that to become permitted or required, as has long been debated.
We document that the adoption of IFRS leads to capital market benefits even in a setting having few ex ante differences between domestic standards, that is, Canadian Generally Accepted Accounting Principles (CGAAP) and IFRS. The findings may be useful to companies in transition to IFRS and regulators and policy-makers reviewing financial reporting requirements.
2. Related literature review
Prior studies dealing with the impacts of IFRS adoption have provided somewhat mixed results, with some being notable for positive findings (Ashbaugh and Pincus, 2001; Ball et al., 2003; Barth et al., 2008; and Landsman et al., 2012; Dayanandan et al., 2016) and other being neutral or negative regarding changes in accounting quality (Ahmed et al., 2013a; Burnett et al., 2015; and Liu and Sun, 2015). Dayanandan et al. (2016) suggest that the adoption of high quality standards, such as IFRS, reduces income smoothing and earnings management. In addition, the study finds that earnings management has decreased in the post-IFRS period in particular for French and Scandinavian civil law countries, but not for German civil law countries and common law countries. The latter can be explained by the fact that common law countries have strong investor protection laws, strict law enforcement and high disclosure levels of financial information. The study also finds empirical evidence that the adoption of IFRS reduces earnings management in countries with high levels of financial disclosure. Overall, the study shows that the adoption of IFRS improved the quality of financial reporting. Brochet et al. (2013) and Horton et al. (2013) provide evidence to support the expectation that even moving from otherwise shareholder-oriented financial reporting regimes to IFRS will provide significant improvements in decision usefulness to equity investors.
The adoption of IFRS in Canada has prompted studies on the effects of implementing IFRS. Burnett et al. (2015) and Liu and Sun (2015) found no evidence of improvement after the Canadian IFRS adoption. Prior research also documents that differences between individual IFRS and CGAAP values can be large, particularly on the balance sheet, and the volatility of financial statement figures is in most cases higher under IFRS than under CGAAP (Blanchette et al., 2013; Blanchette and Desfleurs, 2011; Salman and Shah, 2011).
Several studies addressed the effects of adopting IFRS on the value relevance of accounting information that are related to the adoption of IFRS at different times and in different countries. These findings are mixed, with some studies showing that adopting IFRS improves value relevance (Bartov et al., 2005; Chalmers et al., 2011) and others showing that it worsens value relevance (Callao et al., 2007), while yet others find no conclusive evidence either way (Horton and Serafeim, 2010). Research conducted by Cormier (2013), based on a sample of 184 Canadian companies composing S&P/TSX index indicates that implementing IFRS enhances the value relevance of earnings but only for companies with good governance.
The present work is intended to extend prior research on the effects of adopting IFRS in Canada by focusing on the impact of the 2011, or earlier, adoption of IFRS financial reporting of S&P/TSX 60 Canadian companies, shares of which are the most actively traded on the Toronto Stock Exchange (TSE).
3. Hypotheses development
To focus attention on the matters of concern in this study, those S&P/TSX 60 companies that adopted US GAAP in lieu of IFRS, as permitted under Canadian regulations, have been excluded. Firms adopting IFRS before 2011 (early adopters) are included, however. The objective is to enable a contrast between reporting under predecessor CGAAP with the restated IFRS-based reporting for the same reporting year. Our primary purpose is to investigate the value relevance of IFRS adoption by comparing the association between accounting measures and market values under CGAAP and under IFRS, with a secondary purpose being to explore the effects of IFRS adoption on commonly used financial ratios.
As to the primary purpose, the role of the information content of accounting numbers in ascertaining security prices/returns has long been one of the most fundamental issues in finance and accounting. Absent a relationship between firm value and numbers in the financial statements, such statements have no value relevance, as long defined by, inter alia, Ball and Brown (1968). Therefore, the empirical investigation of value relevance of accounting information is a direct check on the usefulness of accounting data. We expect that the use of IFRS should provide more useful information to investors, thus narrowing the gap between an entity’s book values and market values, and the present study of shifts from CGAAP to IFRS should confirm this expectation, if true.
Regarding the secondary purpose, our research gives particular attention to certain widely used financial statement ratios. These are deemed important for external users of financial statements, making credit and other decisions and for investment recommendations, and for managers who employ them to, for example, implement plans that improve liquidity, financial structure, leverage, profitability and debt coverage ability. Although ratios report mostly on past performances, they also have predictive uses, providing indications of potential problem areas.
We concur with those, such as Blanchette and Desfleurs (2011), who assert that most differences between IFRS and CGAAP are not because of transformations to the fundamental conceptual framework, except for fair value accounting and the entity theory in consolidation. However, we believe several differences arise because of applications in practice rather than from fundamental concepts, such as displaying non-controlling interests inside equity per IFRS, in contrast to CGAAP. Other such items include those flowing from differences in accounting for asset impairments, depreciation (e.g. component depreciation) and the option to revalue items of property, plant and equipment to fair value. Additionally, adopting international accounting rules for employee benefits and electing to charge accumulated actuarial losses against equity may result in an increase in reported liabilities, decrease in equity and increase in future profits reported by first time Canadian IFRS adopters.
Consequently, IFRS adoption can affect several items of financial statements impacting computed ratios. In this study, we focus on items that have a direct impact on the measurement of liquidity, leverage and profitability. The hypotheses to be tested are as follow.
Accounting measures under IFRS are equal to those under CGAAP.
Financial ratios under IFRS are equal to those under CGAAP.
The adoption of IFRS increases the association between earnings and market valuation of equity.
The adoption of IFRS increases the association between book value of equity and market valuation of equity.
The adoption of IFRS increases the explanatory power of earnings and the book value of equity on market valuation of equity.
4. Sample and research design
4.1 Sample and data collection
We identified the 46 companies in the TSX 60 that moved from CGAAP to IFRS in 2011, or earlier, and obtained complete financial statements and corollary materials for each, for the years surrounding the changeover. Table I presents information about accounting standard, IFRS or US GAAP selected.
Annual financial information for Canadian IFRS adopters was drawn from original annual reports prepared in accordance with CGAAP presented for the year before the IFRS adoption (i.e. the comparative year) for the same date and period, from the respective company’s website or Bloomberg. Additionally, data were hand mined from the reconciliations required by IFRS 1 and explanations in the disclosure notes included in the “Transition to IFRS Report” available in the first IFRS financial statements, to further observe main differences in figures reported under IFRS and using CGAAP. All financial information is presented in Canadian dollars (CAD).
The size of companies in the sample varies considerably: total assets range from 1.86bn to 793.83bn under IFRS (1.89bn to 751.70bn under CGAAP), total liabilities extend from 373.43mn to 752.37bn under IFRS (373.43mn to 708.05bn under CGAAP), while total shareholders’ equity ranges from a low of 1.31bn to a high of 44.00bn under IFRS (1.33bn to 46.85bn under CGAAP). The accounting measures of financial performance exhibit significant range values within this sample. Net profit or loss varies from negative 1.53bn to positive 6.05bn under IFRS (negative 350.6mn to positive 5.27bn under CGAAP), while the range for comprehensive income extends from negative 2.35bn to positive 5.12bn under IFRS (negative 1.06bn to 5.33bn under CGAAP). Generally, the range of values is larger under IFRS than under CGAAP.
The following industry sectors are represented in our sample of 46 companies switching from CGAAP to IFRS in 2011 or earlier: 12 (26 per cent) Basic Materials [including 11 (24 per cent) Energy; 9 (19 per cent) Metals and Mining and 2 (4 per cent) Chemicals]; 9 (20 per cent) Financial Services [including 5 (11 per cent) Banks, 3 (7 per cent) Insurance and 1 (2 per cent) Asset Management]; 4 (9 per cent) Technology; and 11 (24 per cent) other sectors, including Consumer Defensive (5), Consumer Cyclical (2) Industrials (2), Utilities (1) and Communication Services (1). Sample companies are classified based on the industry sector and group classification found on TMXMoney. Table II presents sample companies by industry sector and market capitalization during 2008-2012.
The relatively high concentration in our sample companies in the Basic Materials and Energy, as well as in the Financial Services, industry sectors likely reflect the dominance of these industries in the Canadian economy. Additionally, because we find that similar key accounting policy differences affected companies in Basic Materials/Energy, and in Financial Services sectors, key financial figures and ratios are also presented separately for those sectors, to investigate industry effects.
4.2 Financial statement effects
To examine whether capital market participants find reported amounts computed in accordance with IFRS to be more relevant information, we investigate the value of two summary accounting measures – book values and net income – measured under CGAAP and IFRS. Liu (2011) suggested that net income under IFRS is still not completely comparable to net income under US GAAP and that the adjustment for tangible assets revaluation is a major contributor to the difference.
Value relevance refers to the ability of the accounting measures to reflect the underlying economic value of the company, which we measure through contemporaneous share prices, as per Hung and Subramanyam (2007), serving as proxies for the fundamental value of the company. We thus investigate the extent to which the alternative measurements correlate with the information set used by investors in determining share prices.
Financial statement effects of adopting IFRS are analyzed by comparing mean, medians and standard deviations of selected accounting measures and financial ratios calculated for the same period under CGAAP and under IFRS. The t-test, Wilcoxon Signed-Rank test and F-test are used to test the significance of differences among accounting measures and financial ratios under the two accounting regimes. Using Minitab, both statistical non-parametric and parametric techniques are based on a null hypothesis assuming that changes in differences are equally in means, medians and standard deviation.
In addition to the foregoing fundamental financial statement measures, we examine eight ratios that rely on financial statements. These ratios are as follows:
current ratio, CR, defined as current assets divided by current liabilities;
debt-to-assets, DTA, defined as total liabilities divided by total assets;
debt-to-equity, DTE, defined as total liabilities divided by total equity;
return on assets, ROA, defined as net income divided by total assets;
comprehensive return on assets, CROA, defined as comprehensive income divided by total assets;
return on equity, ROE, defined as net income divided by book value of equity;
profit margin, PM, defined as net income divided by sales revenue; and
net income divided by total comprehensive income NI/CI.
4.3 Value relevance
If IFRS indeed improves value relevance, then we expect a significant association between the summary financial accounting measures, book value and net income and the market values of companies that adopted IFRS. We test this by including a dummy variable for the post-adoption period (e.g. 2011-2013) and interaction variables between the dummy variable, book value and net income (see also Liu ea, 2011). If the adoption of IFRS has value relevance, then we expect a significant influence of the dummy and the interaction variables on the market value of companies that adopted IFRS. We use a panel data analysis by following the same set of companies during the pre- and post-IFRS adoption period to measure the impact of the book value and net income on the market value of the same set of companies during these two periods.
Annual financial information was drawn from the CRSP/COMPUSTAT merged database over the period 2008-2013, separately for the three-year period before the adoption of IFRS and the three-year period after the adoption, identifying also the seven companies that were early IFRS adopters and the three-year period before and after the year of IFRS adoption. Our final sample contains 46 companies that converted from CGAAP and reported under IFRS in 2011 or previously.
We use panel data regression (time-fixed effects) to test the value-relevance model of IFRS adoption:
MVi,t = total market value of equity for firm i, which is equal to the market price per share times the number of outstanding shares at the end of period t;
NI = net income;
BVE = book value of common equity;
POST = dummy variable, which equals one for the period 2011-2013 (post-IFRS adoption) and is zero otherwise;
MTB = Market-to-Book ratio is defined as the market value divided by total assets;
SIZE = logarithm of total assets;
LEV = total liabilities divided by total assets;
CFO = cash flows from operations divided by total assets;
INS = the proportion of institutional shareholdings;
EM = EM represents earnings management by using discretionary accruals. The discretionary accruals are estimated by using the modified Jones model; and
= the error term.
Most studies on value relevance use OLS regression analysis. We use panel data analysis, which can be considered as more powerful when conducting cross-sectional and in-time analysis among companies. Because of weakness of Cramer statistic on R-square, we used interaction terms as suggested by Hope (2007). The dummy variable POST takes the value of one for the period 2011-2013 and is zero otherwise. Prior research, for example, Barth, (2001), Bartov et al., (2005) and Liu et al. (2011), used stock returns and stock prices as dependent variables. We used the market value of equity as dependent variable, consistent with, for example, Macías and Muiño (2011). If the adoption of IFRS generates value-relevance, then the coefficients for the term interacting with POST are expected to be positive and statistically significant (ß4 and ß5). Chen and Rezaee (2012) examined the role of corporate governance in convergence with IFRS. We investigated impact of institutional shareholdings on value relevance. Finally, we tested the impact of IFRS on earnings management, which has been a focus point of several studies (Noh et al., 2017; Liu et al., 2014; Liu and O”Farrell, 2011).
5. Empirical results and discussion
5.1 Financial statement effects
5.1.1 Effects on all sample companies.
Panel A of Table III provides descriptive statistics on key accounting measures reported in the statement of financial position and comprehensive income.
Both total assets and total liabilities are found to be higher under IFRS than under CGAAP: the mean total assets and the mean non-current assets under IFRS are higher than under CGAAP at p ≤ 5 per cent and at p ≤ 10 per cent, respectively, while the mean total liabilities under IFRS are higher than under CGAAP at p ≤ 10 per cent. This implies that IFRS either recognizes more asset and liability items in the statement of financial position or that it measures them at higher values or both. Assets are higher primarily as a result of fair value accounting for investment property, consolidation, securitization and financial instruments. Higher liabilities are caused by an increase in the defined employee benefit obligation, consolidation, asset retirement obligations and deferred taxes (See Summary of Significant Accounting Standard Differences between IFRS and CGAAP). These differences are almost offset in shareholders’ equity, which is insignificantly increased under IFRS.
IFRS 1 First-time Adoption of IFRS: Optional exemptions in IFRS 1 to the general requirement for full retrospective application of IFRS that are available on the transition date include: Property, plant and equipment (PPE) reported at deemed cost (i.e. fair value); cumulative translation gains or losses in AOCI reclassified to retained earnings; decommissioning liabilities re-measured; and all cumulative actuarial gains and losses recognized in opening equity.*
Financial Instruments – Recognition and Measurement (IFRS 9)**: Certain equity securities that are measured at fair value under IFRS were measured at cost under CGAAP. As to derecognition of financial instruments, securitization transactions, including transfers of financial assets to QSPEs, are more likely to be accounted for as secured borrowings in IFRS 9, rather than as sales using CGAAP. Also, the criteria for hedge accounting may differ under the two accounting frameworks.
Property, Plant and Equipment (IAS 16): PPE may be revalued to fair value if fair value can be measured reliably. Also, componentization – each part of an item of PPE with a cost that is significant in relation to the total cost is depreciated separately under IAS 16 (“component depreciation”).
Investment Property (IAS 40): Investment property is measured at fair value under IAS 40 and any changes in fair value in net income during the period of change. Under CGAAP, it is measured at historical cost and depreciated over its estimated useful life.
Impairment of Assets (IAS 36): Under IFRS, recoverability of PPE is based on the higher of fair value less costs to sell and value in use (when the undiscounted future cash flows exceed the net carrying amount) of the asset group. Two-step impairment test in CGAAP.
Impairment of Goodwill) (IAS 36): Goodwill is tested at the CGU level under IAS 36, a more granular level than a “reporting unit” level under CGAAP, which may result in impairment charges upon transition to IFRS and more frequent impairment charges going forward under IFRS.
Employee Benefits (IAS 19)***: Different accounting for actuarial gains and losses as well as differences in the measurement of the defined benefit obligation and plan assets (e.g. the use of fair values for determining the expected return on pension assets) in IAS 19 versus CGAAP result in significant reconciling adjustments in transition to IFRS.
Revenue (IAS 18)****: Revenue recognized when all significant risks and rewards of ownership are transferred to the purchaser. Differences in application guidance in IFRS and CGAAP available in various other related standards.
Business Combinations (IFRS 3): Applying the acquisition method may result in transactions being recognized as business combination under IFRS 3 that would not be recognized under CGAAP. Also, acquisition-related costs, other than debt or equity issue costs, are expensed in IFRS, included in goodwill in CGAAP.
Non-controlling Interest (IFRS 3): Non-controlling interest is included in equity under IFRS 3, presented within liabilities or in-between liabilities and shareholders’ equity in CGAAP. Also, share of profit/loss attributable to non-controlling interest recognized in equity in IFRS, treated as an expense/revenue in calculating consolidated profit/loss in CGAAP.
Consolidated Financial Statements (IFRS 10): Consolidation based on a control model in IFRS 10, which is broader than the two frameworks: the voting interest model or, when the entity is a VIE, the variable interest model applied under CGAAP. Several entities, including certain private equity investments and financing vehicles that were not consolidated under CGAAP, are consolidated under IFRS.
Asset Retirement Obligation (IAS 37): Asset retirement obligation (ARO) (also called decommissioning liabilities) is measured under IAS 37 using a risk-free interest rate and is re-measured using the period end discount rate. Under CGAAP, no subsequent re-measurement is required.
Exploration and Evaluation Assets (IFRS 6): Under IFRS 6, the classification of activities designated as exploratory or developmental determines the appropriate treatment and classification of the costs incurred while the full cost approach was available in CGAAP. Also, capitalized exploration and evaluation costs (E&E) are presented separately from PP&E as E&E assets.
Share-Based Compensation (IFRS 2): Outstanding share-based compensation is measured at fair value under IFRS. It is measured at the intrinsic value in CGAAP. Furthermore, under IFRS, forfeitures are estimated on the grant date and included in the measurement of the liability.
Deferred Tax (IAS 12): In transition to IFRS, Deferred Income Taxes are adjusted to reflect the tax effect arising from the temporary differences between IFRS and CGAAP. All deferred taxes are classified as non-current under IFRS.
[Notes: *This option is no longer available in IFRS 1. Other exemptions applied include no restatement of business combinations or share-based payments; **IFRS 9 Financial Instruments, issued in 2014, completed the IASB’s project to replace IAS 39; ***Amended IAS 19, effective from 2013, eliminated the existing option to defer actuarial gains and losses (“corridor approach”); ****In 2014 IFRS 15 Revenue from Contracts with Customers was issued (effective for annual periods beg. January 1, 2017).]
Regarding the statement of comprehensive income, the equality of means is statistically rejected for sales revenue at p ≤ 10 per cent. This is consistent with previous findings that companies are more likely to report a noticeable lower sales figure in IFRS than in CGAAP. Differences in profit or loss in IFRS and CGAAP are mostly because of fair value adjustments, consolidation and equity-method accounting, impairments and the share of profit/loss attributable to non-controlling interests in IFRS. The ratio of profit or loss to comprehensive income is higher under IFRS, because comprehensive income is predominantly lower in IFRS than in CGAAP. This is largely a result of the negative adjustments made under IFRS 1 to other comprehensive income (OCI) at the date of transition and related, for example, to resetting to zero cumulative translation differences and accumulated actuarial losses (See Summary of Significant Accounting Standard Differences between IFRS and CGAAP).
There are also differences between the mean and median results, because the mean takes into account all observations, making this statistic sensitive to extreme values, whereas the median is not so affected. The equality of medians for non-current assets is rejected at p ≤ 10 per cent and for total liabilities and long-term liabilities, which are higher under IFRS, is statistically rejected at p ≤ 1 per cent. The difference between the mean and median indicates the influence of outliers in distorting the mean, common to small samples. Also, we find that the equality of standard deviations is rejected for total assets at p ≤ 10 per cent, which suggests that greater volatility (measured as variance) exists in reported non-current assets in IFRS among companies represented. This comports with previous findings, for example, in Blanchette et al. (2013), indicating higher variability of book value and net income under IFRS.
The presentation of non-controlling interests in shareholders’ equity under IFRS and between liabilities and equity, or in liabilities under CGAAP, may represent a key accounting difference for companies transitioning to IFRS, resulting in an increase in equity. For example, TD Bank Group, at the date of transition to IFRS, recognized an increase in equity of CAD 1,493mn from reclassification of non-controlling interests to equity.
Panel B of Table III provides descriptive characteristics on key financial ratios. The DTE ratio is a measurement of a firm’s degree of leverage. We find that the equality of means of IFRS and CGAAP financial ratios, which are higher under IFRS, is statistically rejected for DTE and ROE ratio at p ≤ 5 per cent. This is consistent with the results of prior studies, such as that by Iatridis and Rouvolis (2010), which they attributed to enhanced credibility of reported financial numbers under IFRS. The equality of medians is statistically rejected for DTA at p ≤ 10 per cent as well as for DTE, ROE and NI/CI at p ≤ 1 per cent. Financial ratios also show some volatility (measured as variance). The equality of variances of is statistically rejected for two ratios: ROE at p ≤ 10 per cent and NI/CI at p ≤ 1 per cent, which reveal greater volatility in CGAAP, implying that IFRS tends to smooth differences in those ratios among sample companies. There are significant differences between CGAAP and IFRS, as highlighted in (See Summary of Significant Accounting Standard Differences between IFRS and CGAAP), which directly affect those ratios, for example, recognizing cumulative translation gains or losses as well as actuarial gains and losses in opening equity in accordance with IFRS 1. A study of Canadian early IFRS adopters conducted by Hilliard (2013) indicates that volatility in earnings under a previous GAAP system is adjusted or corrected through the transition to IFRS.
Our sample results suggest that, in the aggregate, the amounts reported as book value of equity and net income under CGAAP do not change significantly after adopting IFRS. However, several financial statement measures and ratios are affected significantly in transition to IFRS. Therefore, the results are partially supportive of H1a and H1b. The analyses of key figures and financial ratios in CGAAP and IFRS were performed separately for companies representing the Basic Materials/Energy and Financial Services sectors. The results are presented in Tables IV and V.
5.1.2 Effects on basic materials and energy companies.
Panel A of Table IV A provides descriptive statistics on key accounting measures for Basic Materials and Energy sample firms.
Non-current assets and book value of equity are lower under IFRS: the mean and median non-current assets under IFRS are lower at p ≤ 5 per cent, while mean (median) book value of equity under IFRS are lower than under CGAAP at p ≤ 5 per cent (p ≤ 1 per cent). This implies that IFRS either recognizes less non-current asset items in the statement of financial position or that it measures them at lower values or both. Lower valuations result from accounting for depreciation (e.g. component depreciation under IFRS), amortization, depletion, impairments, exploration expenses and decommissioning and restoration costs. Differences in accounting for employee benefits (i.e. increase in the defined benefit obligation) and recognizing an increase in deferred taxes also significantly contributed to lower equity reported under IFRS (Tables VI and VII).
Accounting policy differences regarding asset retirement obligations, mainly related to the discount rate used to measure the provision, significantly impacted companies representing this sector during transition to IFRS. Under IFRS, changes in obligations to dismantle, remove and restore items of PPE (i.e. asset retirement obligations or decommissioning liabilities) are measured under IFRS using a risk-free interest rate and are re-measured at the end of each reporting period to reflect a change in the discount rate. Under CGAAP, no subsequent re-measurement is required.
Also, under IFRS, the classification of activities designated as either exploratory or developmental determines the appropriate treatment and classification of the costs incurred. As a result, certain exploration costs capitalized under CGAAP using the full cost approach are expensed under IFRS, resulting in a decrease in exploration and development assets. In addition, capitalized exploration and evaluation costs (E&E) are presented separately from PPE as E&E assets in IFRS. Consequently, this requires a reclassification of E&E costs out of PPE and reporting them as a separate line item in the statement of financial position in transition to IFRS, which significantly decreased the amount reported as PPE (Tables VI and VII).
Panel B of Table IV A provides descriptive characteristics on key financial ratios. The results reveal that the equality of means is statistically rejected for DTE at p ≤ 1 per cent and for ROE at p ≤ 5 per cent, as the ratios are higher under IFRS. Our findings suggest that the higher ratios under IFRS mainly result from higher liabilities and lower book value of equity under IFRS. The equality of medians is rejected for DTA at p ≤ 10 per cent as well as for DTE p ≤ 1 per cent, ROE at p ≤ 5 per cent and NI/CI at p ≤ 1 per cent. There also is greater volatility under CGAAP, for two ratios: CRA p ≤ 10 per cent and NI/CI at p ≤ 1 per cent.
5.1.3 Effects on finance companies.
Panel A of Table V provides descriptive statistics on key accounting measures for sample Finance firms.
Companies in the Finance sector report both total assets and total liabilities higher under IFRS. The mean (median) total assets under IFRS are higher than that under CGAAP at p ≤ 5 per cent (p ≤ 1 per cent), while mean (median) total liabilities under IFRS are higher than that under CGAAP at p ≤ 10 per cent (p ≤ 5 per cent). This implies that IFRS either recognizes more asset and liability items in the statement of financial position or that it measures them at higher values or both. Higher assets recognized under IFRS result from fair value measurements under IFRS, differences in the scope of consolidation accounting (e.g. consolidation of special purpose entities (SPEs)) and recognition of financial assets transferred in securitization transactions. However, the amounts of total assets reported by the sample companies were also often affected by impairments of intangibles and other assets (Tables VI and VII).
Higher liabilities under IFRS related predominantly to employee benefits, consolidation and on-balance sheet accounting for securitization transactions (derecognition), share-based payments and deferred tax. Although differences between assets and liabilities mostly offset, the largest negative difference in equity values is 65 per cent and the largest positive difference is 207 per cent under IFRS. Because liabilities have generally increased more than equity, IFRS adoption increases the average debt-to-equity ratio.
Panel B of Table V reveals that the equality of medians of IFRS and CGAAP figures is statistically rejected for three financial ratios, DTE, ROA and CROA, at p ≤ 10 per cent, resulting from differences in values of assets and liabilities. Greater volatility (measured as variance) is noted for DTA, ROA, CROA and NC/CI at p ≤ 1 per cent. These results imply that IFRS tends to magnify differences in those ratios, consistent with previous studies that examined early adopters of IFRS in Canada and found higher volatility of financial ratios under IFRS.
On average, banks included in the financial services sector reported lower equity after implementing IFRS, primarily because of significant transition adjustments for employee benefits, securitized mortgages previously derecognized, the fair value of private equity securities and the consolidation of certain SPEs. There were also increases because of the consolidation of SPEs.
5.1.4 Main accounting standard differences.
The objectives of general purpose financial reporting under IFRS are targeted to provide useful information primarily to equity investors and other capital providers in making resource allocation decisions. Two primary qualities of useful information are relevance and faithful representation, both deemed enhanced by the use of fair value measurements.
Table VI shows major book value of equity reconciliation categories (in million) in the order of their frequency.
Deferred tax is the most frequent adjustment item among all sample firms, with a frequency of 38 out of 46 observations. Deferred tax differences reflect the tax effect of temporary differences arising between IFRS and CGAAP, mostly because of IFRS use of fair values. The average effect is to reduce equity (mean reduction, 182), but the standard deviation of 590 is higher because of the presence of both equity increasing (i.e. recognition of deferred tax assets) and equity decreasing (i.e. deferred tax liabilities) adjustments.
Employee benefits (pension) adjustments (35 firms) significantly affected Canadian companies’ reported equity and results in transition to IFRS. This is because of (a) decisions regarding off-balance sheet amounts at the transition date, (b) differences in accounting rules and (c) amended IFRS effective in 2013. One of the exemptions that Canadian companies could elect in transition was to recognize all previously unrecognized cumulative actuarial gains and losses at the transition date. Under pre-changeover CGAAP, actuarial gains and losses were allowed to remain unrecognized for extended periods of time. This option results in a one-time increase in reported liabilities and a decrease in reported equity and, consequently, avoids recognition of losses in transition to IFRS and subsequently. However, this one-time adjustment significantly impacts balance sheet equity (mean reduction, 412; standard deviation, 748). Financial services companies that have to meet regulatory capital requirements may be hesitant to choose this one-time adjustment to equity at transition (e.g. Manulife). However, Manulife decided to apply another election by writing off cumulative translation losses of 5,148 million against equity. In our sample, 31 companies elected to write-off actuarial losses against equity.
Fair value measurements are significant to many IFRS financial statements, particularly regarding the opening balance sheet at transition date, which often reflects the revaluation of several assets to fair value. Fair value adjustments observed in the sample companies come from one-time adjustments at the date of transition (i.e. fair value as deemed cost under IFRS 1), fair value measurements (e.g. for investment property, financial instruments) and revaluation models for PPE, as well as intangible assets (if there is an active market). Thus, FV adjustments are part of several reconciling items presented in Table VI (See Summary of Significant Accounting Standard Differences between IFRS and CGAAP).
Non-controlling interest adjustments increase book value of equity (mean, 852; standard deviation, 1,905) and are required because under IFRS this item is presented in equity, and the related share of profit/loss is treated as a capital adjustment. Under CGAAP, non-controlling interest is presented either between liabilities and equity or in liabilities, and the relevant share of profit/loss is in consolidated profit/loss.
Consolidation under IFRS is based on the principles of control, which is broader than the two allowable models (variable interests and voting interests) under CGAAP. Also, proportional consolidation is not allowed under IFRS. Consequently, more entities were consolidated and more joint ventures recognized under the equity method using IFRS, resulting in increased assets, liabilities and non-controlling interest. On average, consolidation reduced equity of our sample companies (mean, 15; standard deviation, 266).
Goodwill is tested for impairment under IFRS at the more granular cash generating unit level, which may result in impairment charges upon transition and more frequent future impairment charges. Firms in the insurance industry were significantly affected by goodwill impairment charges (in CAD million): Manulife (2,025) and SunLife (1,771). Henry et al. (2009) found that pensions and goodwill were the most dominant reconciliation items.
One of the biggest challenges in transitioning is assessing which accounting policies to use. For example, IFRS 1 provides optional exemptions from full retrospective application of IFRS accounting policies, available only at the date of transition. The effects on prior periods of optional exemptions from some requirements of IFRS (other than IFRS 1) are recognized as one-time adjustments in shareholders’ equity, often in retained earnings. Furthermore, IFRS 1 optional exemptions, such as measuring PPE in the opening statement of financial position at a deemed cost and recognizing accumulated actuarial losses as well as foreign currency translation effects directly in equity at the date of transition decrease equity. The Summary of Significant Accounting Standard Differences between IFRS and CGAAP presents main accounting standard differences between CGAAP and IFRS.
5.2 Value relevance
We now address the value relevance comparison between the period before IFRS adoption and the period after the adoption of IFRS. Value relevance is measured in terms of accounting measures’ ability to estimate market capitalization. The results in Table VII show that the adjusted R-square of the panel data regression for the post-IFRS period (adjusted R2 = 0.5135) is higher than the adjusted R-square for the pre-IFRS period (adjusted R2 = 0.1650) which indicates higher value relevance for net income and equity reported after the adoption of IFRS (H3) in Canada in 2011 (H3). The Coefficient ß4 of 1.759 for POST × is positive and statistically significant at the 1 per cent level. This result is in line with Cormier and Magnan (2016), who showed that migrating from Canadian GAAP to IFRS enhances the value relevance of earnings, but the effect is concentrated among firms that are cross-listed in the US Coefficient ß5 of 0.226 for POST × is also statistically significant at the 1 per cent level. These results confirm H2.
Furthermore, Table VII shows that growth opportunities (proxied by MTB) have a positive impact on value relevance (p-value < 0.01). Other control variables such as firm size (SIZE) and leverage (LEV) are not significant. The coefficient of the control variable related to Cash Flows from Operations (CFO) is negative and significant at the 1 per cent level. This result is in alignment with the free cash flow theory (Jensen, 1986) which predicts that firms generating cash in excess of that required to fund positive NPV projects face greater agency problems and are more likely to invest in value-decreasing activities. We do not find empirical evidence of institutional shareholdings (INS) and reporting incentives (earnings management) on value relevance. We estimated reporting incentives by using discretionary accruals, estimated using the modified Jones model (Jones, 1991). A multicollinearity check was also performed. The variance inflation factors (VIF) are for all variables below 4. The correlation matrix (not shown here) also indicates that multicollinearity does not appear to be a problem. To decide between fixed or random effects, we ran a Hausman test. The test indicated that the preferred model is fixed effects. In our panel data analysis, we used fixed year effects to capture the influence of aggregate (time‐series) trends.
We divided our sample into firms that are cross-listed on the TSX and NYSE/Nasdaq, and firms that are only listed on TSX. Table VIII shows the empirical results. Interestingly, our results indicate that earnings of cross-listed firms after the adoption of IFRS contains more value relevance than earnings of non-cross-listed firms. The coefficient β4 of 2.376 for POST × is statistically significant at the 1 per cent level. The same coefficient for non-cross-listed firms is negative and insignificant. We divided our sample into Basic Materials/Energy (22 companies) and other industries (24 companies). Table VIII shows that higher value relevance is identified for earnings and equity after the adoption of IFRS in the Basic Materials/Energy sector. The coefficient β4 is positive, but not significant. Coefficient ß5 of 0.824 for POST × is statistically significant at the 1 per cent level. The coefficients for earnings and equity in the post-IFRS period are negative in non-basic industries.
Overall, our results confirm our hypotheses that the adoption of IFRS improves value-relevance. Liu et al. (2011) and Jermakowicz et al. (2007) found similar results for China and Germany. Our results on earnings are in alignment with the international meta-study of Ahmed et al. (2013b). They conclude that the overall meta-analysis results show that the adoption of IFRS increases earnings value relevance. These results hold for all common law systems.
This paper investigates the impact of adopting IFRS in a financial reporting environment that ex ante has domestic standards similar to IFRS (AcSB, 2011). Our focus is on Canadian companies from the S&P/TSX 60 index, representing dominant industries in the Canadian economy. Most of those companies choose to apply IFRS although companies cross-listed in the USA were permitted to report under US GAAP. We investigate the financial statement effects on those (46) companies from the S&P/TSX 60 index which report under IFRS in 2011, having switched from CGAAP. Three major findings emerge from our analyses.
First, our study confirms findings by Blanchette et al. (2013) that at the aggregate level, IFRS adoption does not significantly change the central values that depict the financial position and performance of Canadian companies in financial statements. Our results suggest that the fundamental values of book value of equity and net income under CGAAP do not change significantly after adopting IFRS. However, several financial statement measures and ratios are affected significantly in transition to IFRS.
Second, we add to prior studies documenting significant industry effects in transition to IFRS (Blanchette et al., 2013; Hilliard, 2013). We find that noncurrent assets and book value of equity are lower under IFRS than under CGAAP for firms in the Basic Materials and Energy sectors, mainly from differences in accounting for exploration and evaluation assets, decommissioning liabilities, asset impairments, depreciation, amortization and depletion, as well as optional exemptions in IFRS 1. Our sample companies in the Finance sector report both total assets and total liabilities higher under IFRS, mainly as a result of fair value measurements, consolidating SPEs, recognition of financial assets transferred in securitization transactions and recognition of employee benefits (See Summary of Significant Accounting Standard Differences between IFRS and CGAAP).
Third, we add to the literature investigating whether IFRS adoption alters the information environment within countries that ex ante have domestic standards similar to IFRS (Brochet et al., 2013). The transition from CGAAP to IFRS provides investors with more relevant information by reducing the information gap between accounting measures and market values. The book value of equity and earnings have greater explanatory power regarding market values after adopting IFRS (Table VII). Therefore, it appears that transition from CGAAP to IFRS provided more useful information to investors, thus reducing the gap between an entity’s financial information and market values. Additionally, earnings of cross-listed firms after the adoption of IFRS seemingly contain more value relevance than earnings of non-cross-listed firms (Table VIII). Higher value relevance is also identified for earnings and equity after the adoption of IFRS in the Basic Materials/Energy sector (Table VIII). We observe an enhancement in the value relevance of earnings and equity following IFRS adoption. Our results show that earnings and equity are the most value relevant factors. These empirical ﬁndings may be of interest to US regulators, as the Canadian context is comparable to the USA situation in many aspects.
We acknowledge several limitations of our study. First, our relatively small sample size compared to typical market-based analyses limits generalizability and the power of our empirical analyses. Also, the companies in our sample were heavily concentrated in two industry sectors: Basic Materials/Energy and Financial services. Second, the analysis is restricted to Canadian companies and as such results from this study may not be generalized to other countries. Also, the information environment differs and, consequently, share prices used in value-relevance studies may incorporate information in a different manner across companies (Soderstrom and Sun, 2007). Finally, the development of IFRS is a continuing process and IASB has recently enacted several standards affecting recognition, measurement and presentation of important economic activities, which may affect future IFRS adoptions.
Academicians are encouraged to develop future research that expands on our results regarding the potential benefits to investors from global accounting convergence. Particularly, addressing the extent to which companies adopt IFRS and which IFRS accounting policies are selected, as well as its impact on the quality of accounting information, should be explored and will be of interest to investors, regulators, standard setters and publicly traded companies.
This study is motivated by the US SEC’s current deliberations over whether US companies should be permitted or required to report under IFRS. Because financial reporting and legal environments in the USA and Canada are similar, we expect that the Canadian experience in adopting IFRS would probably resemble the situation that the US companies would face if the US SEC decides to require IFRS or permits companies to choose between US GAAP and IFRS. However, this view is subject to the following considerations:
CGAAP has gradually evolved towards IFRS during at least five years, from the initial announcement in 2006, to the actual changeover in 2011. For example, in 2007, the AcSB eliminated the LIFO inventory costing method to converge with IFRS and, in 2009, accounting for development costs was converged with IFRS. These are two major differences between IFRS and US GAAP that many consider as impediments to adopting IFRS in the USA (AcSB, 2011).
The impact of adopting IFRS on the financial statements of Canadian companies representing financial services may be significantly different than the potential effects of IFRS adoption on US financial institutions. This is because Canadian banks were not as involved in the sub-prime lending and securitization activities (Abdel-khalik, 2013).
Because IFRS is more principles-based than US GAAP, there are several areas where IFRS and US GAAP involve different levels of judgment (e.g. consolidation accounting).
2011 S&P/TSX 60 Firms’ accounting standard choice: IFRS or US GAAP
|S&P/TSX 60 firms||60|
|Switch to IFRS|
|From Canadian GAAP to IFRS
From US GAAP to IFRS
|Reporting under US GAAP|
|Using US GAAP before 2011*||7|
|Switched from Canadian GAAP to US GAAP||6||13|
Note: *Excluding one firm which switched from US GAAP to IFRS
S&P/TSX 60 Canadian firms by industry sectors and market capitalization
|Panel A: Market capitalization (in CAD million)|
|Firms using IFRS||47||14,453.73||18,435.18||22,182.39||19,085.12||19,900.61|
|Firms using US GAAP****||13||10,306.60||12,132.65||14,781.20||16,399.14||18,939.15|
Note: *include Energy (11), Metals and Mining (10) and Chemicals (2);
**include Banks (5), Insurance (3) and Asset Management (1);
*** include Consumer Defensive (5), Consumer Cyclical (2) Industrials (2), Utilities (1) and Communication Services (1);
****Include: Utilities (3), Services (3), Healthcare (2), Energy (2), Basic Materials (1), Consumer Cyclical (1) and Technology (1)
Tests of equality for all sample firms – means, medians, and standard deviations
|(in CAD million)||IFRS||CGAAP||t-tests||Sig.
(N = 46)
Notes: Variable definitions: CR is current ratio, which equals current assets divided by current liabilities; DTA is debt-to-assets, defined as total liabilities divided by total assets; DTE is debt-to-equity, which equals total liabilities divided by total equity; ROA is return on assets, which equals net income divided by total assets; CROA is comprehensive return on assets, which equals comprehensive income divided by total assets; ROE is return on equity, which equals net income divided by book value of equity; PM profit margin, which equals net income divided by sales revenue; and NI/CI, which equals net income divided by total comprehensive income;
1The difference in mean is based on t-tests. The difference in median is based on Wilcoxon Signed-Rank tests. The difference in standard deviation is based on F-tests;
Null hypothesis for test of equality of means/medians/variances;
***null hypothesis rejected at the 1 per cent level of confidence;
**null hypothesis rejected at the 5% level of confidence;
*null hypothesis rejected at the 10% level of confidence;
2Include all (46) S&P/TSX 60 firms that reported under IFRS in 2011 and switched to IFRS from CGAAP
Tests of equality for basic materials and energy firms – means, medians and standard deviations
|(in CAD million)||IFRS||CGAAP||t-tests||Sig.
(N = 22)
Note: 3Basic Materials and Energy firms include the following: Energy (11), Metals and Mining (9) and Chemicals (2)
Tests of equality for finance firms – means, medians and standard deviations
|(in CAD million)||IFRS||CGAAP||t-tests||Sig.
measures (N = 9)
Note: 4Finance firms in our sample include the following: Banks (5), Insurance (3) and Asset Management (1)
Descriptive statistics on the book value reconciliation adjustments between CGAAP and IFRS*
|Panel A: Book value reconciliation – all observations (N = 46 firms)|
|Book value, CGAAP||11,187||7,226||10,651||46|
|Property, plant and equipment||−326||−195||1,980||33|
|Asset retirement obligation||−81||−6||429||27|
|Exploration and evaluation||866||128||1,216||11|
|Revaluations to fair value||154||86||325||10|
|Investments in joint ventures, associates||63||22||73||8|
|Book value, IFRS||11,199||7,383||10,537||46|
|Panel B: Book value reconciliation – basic materials (N = 22 firms)|
|Book value, CGAAP||10,131||7,427||8,196||22|
|Property, plant and equipment||−878||−315||1,456||19|
|Asset retirement obligation||−11||−1||206||16|
|Exploration and evaluation||944||300||1,252||10|
|Investments in joint ventures, associates||−88||−39||218||6|
|Book value, IFRS||9,748||7,427||8,196||22|
|Panel C: book value reconciliation – finance (N = 9 firms)|
|Book value, CGAAP||22,522||18,359||14,065||9|
|Property, plant and equipment||8,585||8,585||0||1|
|Book value, IFRS||24,822||23,674||11,408||9|
Note: *All numbers are in CAD millions, as reported in reconciliations from CGAAP to IFRS
Panel data regression results using time-fixed effects of IFRS adoption of TSX 60 firms from 2008-2013
|Firm year observations||n = 138||n = 138||n = 276||n = 276|
The dependent variable is equal to the firm’s market value scaled by the firm’s market value in the previous year. The variable NI is defined as net income. The variable BVE is the book value of common equity. POST is a dummy variable, which equals one for the period 2011-2013 (after adoption) and is zero otherwise. The variable MV is the market value for the firm, which is equal to the market price per share times the number of outstanding shares. Market-to-Book ratio (MTB) is defined as the market value divided by total assets. The variable SIZE is the logarithm of total assets. The variable LEV is defined as total liabilities divided by total assets. The variable CFO is defined as cash flows from operations divided by total assets. The variable INS is defined as the proportion of institutional shareholdings. The variable EM represents earnings management by using discretionary accruals. The discretionary accruals are estimated by using the modified Jones model (Jones, 1991);
***, **, * indicate statistical significance at the 1, 5 and 10 per cent level (two-sided), respectively; Robust standard errors are in brackets
Panel data regression results using time-fixed effects of IFRS adoption of TSX 60 firms from 2008-2013
|Firm year observations||n = 189||n = 87||n = 132||n = 144|
The dependent variable is equal to the firm’s market value scaled by the firm’s market value in the previous year. The variable NI is defined as net income. The variable BVE is the book value of common equity. POST is a dummy variable, which equals one for the period 2011-2013 (after adoption) and is zero otherwise. The variable MV is the market value for the firm, which is equal to the market price per share times the number of outstanding shares. Market-to-Book ratio (MTB) is defined as the market value divided by total assets. The variable SIZE is the logarithm of total assets. The variable LEV is defined as total liabilities divided by total assets. The variable CFO is defined as cash flows from operations divided by total assets. The variable INS is defined as the proportion of institutional shareholdings. The variable EM represents earnings management by using discretionary accruals. The discretionary accruals are estimated by using the modified Jones model;
***, ** and * indicate statistical significance at the 1, 5 and 10 per cent level (two-sided), respectively; Robust standard errors in brackets
Appendix. List of TSX-60 firms included in the study
ARC Resources Ltd.
Bank of Nova Scotia
Brookfield Asset Management
Canadian Imperial Bank of Commerce
Canadian Natural Resources
Canadian Oil Sands
Canadian Tire Corp. Ltd.
First Quantum Minerals
George Weston Ltd.
Gildan Activewear Inc.
Inmet Mining Corp
National Bank of Canada
Penn West Petroleum
Potash Corp. of Saskatchewan
Power Corp. of Canada
Royal Bank of Canada
Shoppers Drug Mart Corp.
Sun Life Financial
Thomson Reuters Corp.
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About the authors
Eva K. Jermakowicz, PhD, CPA, is a Professor of Accounting at Tennessee State University. She co-authored Wiley IFRS and other IFRS books, and her primary research interest is in the area of international accounting.
Chun-Da Chen, PhD, is an Associate Professor of Finance in the College of Business at Lamar University in Texas. His field of interest is financial accounting, derivatives and investments. He is the author of many journal articles.
Han Donker, PhD, is a Professor of Accounting in the College of Business and Public Policy at the University of Alaska Anchorage. He is the Editor-in-Chief of the International Journal of Corporate Governance (IJCG). His field of expertise is IFRS, corporate restructuring and corporate governance.