Chapter 9: Perspectives on the drawbacks of IFRSs: Justification of deviations between ideals
9.5.4 Prudence and Earnings Management
It is not clear what drives users’ and preparers’ preferences towards the IFRSs, since they express scepticism over the reliability and trustworthiness of IFRSs-based information. Due to IFRSs failure to provide explicit accounting standards that could be applied uniformly it is questionable whether preparers are able to conduct the best possible financial statements representing the financial performance and value of a company in the most reliable and comparable way. A prerequisite for comparable information is that the IFRSs are ‘properly’
applied and not driven by the self-interests of companies. In this context ‘proper application of the standards’ is a broad issue, since accounting disclosures and measurements are determined by the nature of the accounting framework and their interrelation with companies and the environment or/and sector in which they operate. Proper implementation of IFRSs is sometimes regarded as governed by prudence. The prudence convention, however, is itself contestable, as it can prevent preparers from reliably representing financial performance and companies’ results.
‘When IFRSs are applied with prudence financial results can be comparable. I would like to be able to read the balance sheet of Alpha Bank and that of Deutsche Bank to compare them and decide where to invest or not. But I need to know that there was the required prudence by both, that they applied IFRSs in a proper way, in order for the results to be comparable...’
[AUD7]
‘Theoretically, IFRSs provide more information but I am sceptical about what happens in practice and the quality of this information. For example, in order to improve their capital adequacy, companies buy land in odd regions and show high purchase prices, making use of high fair values. This was the case with the ASPIS scandal.’ [ACD3]54
The notion of ‘appropriate’ financial reporting and opportunities for manipulation emerge often as issues significantly influencing the behaviour of managers and the quality of financial information. Thus, it may be in the management’s self-interest to present a better image ‘by manipulating income in order to get a loan, or increasing the share price, or showing increased sales to get higher bonuses’ [ACD4]. However, another interviewee
54ASPIS Pronoia, member of the ASPIS Group of Companies, is a Greece-based insurance company that collapsed in 2007 after it was revealed that the company had proceeded to increase its capital and adjust the value of immovable property by arbitrarily increasing its value by 50 million Euros.
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remarks that ‘in Greece companies sometimes manipulate earnings downwards rather than upwards in order to pay less tax’ [ACD2].
Such behaviour is considered to be an obstacle to achieving harmonised financial statements that adequately reflect ‘economic reality’ and are transparent. Generally, fair value accounting is thought to increase opportunities for manipulation when “mark to model”
accounting is employed to simulate market prices, because managers can influence both choices of models and parameter estimates by, for instance, influencing financial statements by exercising discretion over realising gains and losses through the timing of asset sales. This is especially true in Greece, where the market is not particularly active.
‘If one wants to manipulate they will manipulate!’ [ACD2]
‘There were some technical problems for banks and other companies on the application of IAS 32 and 39. Regarding, for example, the recognition of impairment on intangible assets there was the case of a company where 1/3 of the net assets comprised intangibles and did not disclose recognised impairments...’ [AUD1]
‘Fair values are ambiguous. Do you know what does it mean to readjust equity capital by 5%? It is a massive number. We look for deviations or spikes in the results, we conduct regression analyses, I may ask for some clarifications from the Investor Relation section […].
IFRSs standard-setters compromise sometimes and are influenced by other interests. They changed the market-to-market policies to save companies like City Group and American International.’ [FA3]
There are options in the valuation methods and the provision for employee compensations and provisions for reduction in the value of inventory. The fair values used to value non- current and intangible assets, such as the rights in takeovers that required impairment tests, offered many opportunities to accountants to: ‘fill in the gaps’ [FA1]. Managers’ self-interest distorts the ability of IFRSs to represent economic reality. As the following comment suggest, earnings manipulation can lead to quality aberrations from economic reality, while the conceptual superiority of IASB’s standards remains unchallenged.
‘IFRSs include accounting principles and subjective estimations and results can be disputable. If the estimations made under IFRSs are ‘correct’ then you have the best possible results. But companies use fair values and models and report whatever numbers they want in
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order to affect the results. Previously, accounting standards were stricter, now they are more flexible and voluminous and thus more complex and of questionable quality.’ [AUD7]
‘IFRSs are the perfect financial reporting system, if properly applied. But in reality, accountants or managers have something in their mind, to meet targets. The financial statements could be flawless if people did not have other things in their mind. The GGAP looks at the real costs and the value of the asset is known when it is sold. IFRSs have fair values and offer more opportunities to manoeuvre and manipulate results.’ [AUD8]
Most interviewees believe that IFRSs allow discretion to both accountants and managers to exercise their judgment; they expressed concerns that IFRSs provide extensive opportunities to firms to influence results through the application of preferred accounting measurement methods and treatments. Increased manipulation becomes more feasible with the use of fair values and the biased evaluations of valuers. Biased valuations are more difficult to inhibit due the lack of an independent Greek state institute providing official licences or certificates to accredit valuers. The only private valuation organisation at the moment in Greece is the Hellenic Institute of Valuation (H.I.V.), established in 2009.
‘Creative accounting is easier and more intense with IFRSs. Often, there are valuers that do not do their job properly and make higher estimations than the real value of the fixed assets or the subsidiary companies.’ [AUD4]
‘IFRSs sometimes give unlimited freedom to accountants. If a company states that it is going to use the buildings for 50 years, no one will disagree. An independent is required for the valuation of buildings, but for some other fixed assets though, such as shelves, [this is a supermarket chain] there are no valuers. Under GGAP we used a depreciation rate of 20%, meaning that they would depreciate in 5 years; under IFRSs this is 10% and depreciation in 10 years.’ [ACT1]
‘IFRSs are adopted by companies in a looser way; there is the subjectivity factor; take for example the valuer who is paid by the company and tends to manipulate the figures in order to agree with the managements directions, it is logical.’ [TAX1]
On the one hand, there is a perception that the ability to manipulate IFRSs reports was more possible in the past, implying that there is less manipulation in the present, due to the strict supervision of the capital market committees and auditors.
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‘It is difficult for companies to hide financial transactions, not that it doesn’t happen. In the past, companies that used IFRSs hid many things’ [BA1]
Conversely, a financial analyst observes the opposite trend:
‘Following the IFRSs adoption companies produced more analytical information […]
however, at some point this started to fade. […] books are kept and results are reported in a way that is more ‘convenient’ for companies’ interests. Getting to know how to treat IFRSs resulted in finding ways to overcome the ‘problems’ that they encountered.’ [FA1]
In general, it could be argued that preparer’s and other users’ view is that accounting manipulation seems to have increased under the IFRSs.
‘Companies feel that with IFRSs there is leeway; my impression is that manipulation has increased with IFRSs.’ [ACD3]
‘The standards that are more prone to manipulation are IAS 16 and IAS 39. With IFRSs the company can manipulate the financial results and equity as they like. Under the GGAP, once you choose to do something you have to commit to it. Under the GGAP the company could get some comments in the auditor’s report regarding figures and accounting treatments that needed e.g. more evidence without any consequences. Under the IFRSs auditors don’t make such comments because the stock markets and the banks will not like this; if there is a comment there will be a problem.’ [AUD6]
Is manipulation easier under IFRSs? Yes. GGAP has clearer rules. In countries with developed markets, book-cooking is high level and more sophisticated. It’s gourmet cooking.
Take the example of financial instruments. According to the Greek standards, the valuation is made on the average price in the middle of December, under IFRSs, according to the last meeting. Can I manipulate or not?’ [AUD9]