Len Skerratt

Earnings quality across different reporting regimes: listed, large private, medium-sized, small and micro companies in the UK

Since the UK Companies Act 1981, there has developed a multi-tier framework for financial reporting. IFRS is designed for listed companies, there is a GAAP for large private and medium sized companies, and the FRSSE is designed for small companies, which also are exempt from mandatory audit. The recent EU Accounting Directive reinforces this strategy and recognises a new class of company, the micro company. However, it is not clear how the quality of reporting is affected by this multi-regime approach, and by the ability to switch between regimes. The purpose of this paper is to assess the smoothness of earnings between the different types of company from 2006-2013, based on 594,000 observations. We find that the earnings of listed companies are the most informative (least smooth), closely followed by small and micro companies. In contrast, the earnings of large private and medium sized companies are much smoother, suggesting that they are under regulated. The results are inconsistent with the equalisation of earnings quality across all groups, and with the discipline of regulation reflecting the size, complexity of companies and their agency issues. Small companies do not exploit the audit exemption to smooth earnings.

The Role and Current Status of IFRS in the Completion of National Accounting Rules – Evidence from the UK

Abstract Drawing on secondary data, we examine the transposition of the Accounting Directive 2013 into UK GAAP with a specific focus on references to IFRS. The process involved consultation and regulatory impact assessment on the options in the Accounting Directive and proposed changes to accounting standards for non-publicly accountable entities. This led to an IFRS-based approach from 2016 with three tiers: EU-adopted IFRS for group listed companies and other publicly accountable entities, an adaptation of IFRS for SMEs for non-publicly accountable entities, and a simplified version for micro-entities incorporating the requirements of the Accounting Directive. This outcome is not surprising since the UK was one of the founding members of the original International Accounting Standards Committee and a strong proponent of little GAAP. Indeed, the UK’s former Financial Reporting Standard for Smaller Entities provided a model for the IFRS for SMEs. In the past, there were few references to IFRS by the UK’s enforcement and interpretation bodies. Today, guidance is taken from IFRS Interpretations Committee. We contribute to the literature by describing the main processes involved in implementing the Accounting Directive and the move to an IFRS-based approach in UK GAAP. Our analysis should be of interest to researchers and policymakers alike.

The impact of the 2007 reforms in China on the quality of earnings

Abstract Prior to 2007, in order to encourage international investment, China operated two parallel financial reporting systems, one based on Chinese GAAP for domestic investors and the other based on IFRS for international investors. In 2007, after a series of reforms to harmonise Chinese GAAP with IFRS, this system was replaced by a single set of standards for both classes of investor. We evaluate the impact of this significant change on earnings quality for stocks quoted on the Shanghai and Shenzhen stock exchanges for the period 2003–2013. Using tests of earnings smoothing and early loss recognition, we identify three key features. Firstly, earnings quality improved consistently over the period. Secondly, prior to the reforms of 2007, IFRS earnings were of superior quality to Chinese GAAP earnings. A third and important finding is that earnings quality under Chinese GAAP after the 2007 reforms is comparable to that under pre-2007 IFRS.

The Impact of the IFRS on the Debt Contracting Process: A Comparison Between UK and Italy

This paper analyzes the economic consequences of the accounting harmonization process in two different institutional settings, the UK and Italy. The UK is a common-law country characterized by low ownership concentration, strong outsider legal protection, and a GAAP which is considered to be roughly equivalent in disclosure quality to the IFRS. Italy is a typical European code-law country, characterized by a weak outside investor protection system, and a GAAP significantly different from the IFRS model. We find that, in the post IFRS period, accounting variables play a larger part in the determination of the cost of debt of Italian companies, enhancing the importance of financial reporting data relative to privately held information about borrowers’ credit ratings. In the UK there is no impact of mandatory adoption of IFRS on the cost of debt of listed companies.

The Impact of False Rejection Risk on Posterior Audit Risk Measurement

This paper investigates false rejection risk, analysing the a priori relationship between the risk of false rejection and the more common risk of false acceptance, of an account balance by a substantive test. The paper uses probability theory to specify the relationship between these two risks and thus generate a model of posterior audit risk. The paper proceeds to investigate the relationship using the power function of basic statistics. This specifies the relationship between (i) the probability of rejecting the account balance and (ii) the size of the error which the balance contains. We argue that unless there is a discontinuity in the power function around the specified value of material error, then posterior audit risk will be unaffected by the substantive tests undertaken. Posterior risk will then be determined entirely by the assessed inherent and control risks. This conclusion is counter-intuitive to the approach to audit risk adopted by many professional pronouncements and results from the adoption of a mathematically rigorous definition of the risks encountered by the auditor. The primary conclusion is that the discontinuity arises under conditions of careful audit planning. If planning is careful, then false rejection risk contributes very little to posterior risk. In addition, there is very little difference between planned risk and posterior risk.