Principle-based Accounting Standards
What accounting standards is principle-based?
IFRS
What accounting standards is rule-based?
GAAP
Two Litigation Theories
Protection Theory
Roadmap Theory
Why mandatory IFRS adoption is expected to reduce the cost of equity capital?
IFRS requires greater financial disclosure than most local accounting standards; one set of uniform accounting standards is likely to improve information comparability across firms
When did the European Parliament pass the resolution of IFRS application?
March 2002
What are the qualitative characteristics of accounting information?
relevance, reliability and comparability
Characteristics of rule-based accounting standards
Scope exceptions;Treatment exceptions; The presence of detailed implementation guidance
What is the protection theory?
incorporates all arguments that make firms less likely to be sued or less likely to lose conditional on being sued
Two Mechanisms to reduce the cost of capital
Increased financial disclosure; Enhanced information comparability
What type of firms that market have negative reaction regarding the IFRS adoption？
firms domiciled in code law countries
What is pooling of interests accounting?
Assets and liabilities are transferred from the acquired company to the acquirer at book values. No goodwill recorded.
What is the inherent trade-off between relevance and reliability?
more timely reporting; reporting is based on transaction amounts with little estimation
includes all arguments that make plaintiffs more likely to file a suit or prevail in a suit conditional on its filing
Why increased financial disclosure would reduce the cost of capital?
greater disclosure mitigates the adverse selection problem and enhances liquidity; firms with greater information disclosure have lower forward-looking betas
What types of firms that market have positive reaction regarding the IFRS adoption?
firms with low quality pre-adoption information: investors expecting that IFRS adoption will result in greater informational benefits; firms with high-quality pre-adoption information asymmetry
What is purchase accounting?
Assets and liabilities are recorded aT fair market value, and any excess of consideration paid for the target over its net tangible assets is recorded as goodwill.
What is the trade-off between comparability and predictive ability?
facilitate interfirm comparisons;
facilitate calculations of intrinsic value
What would happen if increase the extent of principles-based accounting standards?
would weaken safe harbor protection; give plaintiffs a wider menu of potential ‘‘judgment-based’’ allegations in cases not involving an admitted misstatement; increase the threat of litigation for firms
Why enhanced information comparability would reduce the cost of capital?
reduce information asymmetry and/or estimation risk; bring about positive information externalities
Why do investors expect net benefits to IFRS adoption in Europe?
increases in information quality; decreases in information asymmetry; more rigorous enforcement of the standards, and convergence
Pro and Cons of principle-based accounting standards
Pros: Flexible; Encourage professional judgement
Cons: Lack comparability-consistent; Complex and time-consuming
Pros and Cons of Rule-based Accounting Standards
Pros: It’s easier to comply; Increased comparability
Cons: It’s not clear enough and preparers don’t know what actually to look at when complying the rules
What would happen if decrease the extent of rules-based accounting standards?
might make the ‘‘innocent misstatement’’ defense less credible given an accounting restatement; increasing the threat of litigation; reduce the number of restatements in general
Pros and Cons of Accounting Standard Harmonization
Pros: Reduce information asymmetry; Lower the cost of capital; Increase capital flow across borders; Investor and other market participants could better use their current expertise to analyze firms from countries with accounting standards that they are familiar with
Cons: An appropriate set of accounting standards in one country need not be an appropriate set of accounting standards in another country; Increase firm’s costs in complying with the new standards; Lax and inconsistent enforcement may result in limited compliance with the standards and diminished comparability
Costs and Benefits of Following Foreign Firms (Analyst Aspect)
Costs: Direct costs of acquiring information about a new firm; Reputation costs if the analyst does a poor job of forecasting and providing a recommendation about the new firm
Benefits: Broadening the analyst’s industry coverage to include significant foreign firms; Increased commissions for their brokerage firm that accompany expanded coverage and investment recommendations, or investment banking fees