effects of international financial reporting standards on the

Effects of International Financial Reporting Standards on the Accounts and

Accounting Quality of Australian Firms

Kamran Ahmeda, John Goodwinb*

a Department of Accounting, La Trobe University, Melbourne, Vic, 3083, Australiab School of Accounting and Law, RMIT University, Melbourne, Vic, 3000, Australia

AbstractThis study examines the effect of Australian equivalents to International Financial Reporting Standards (AIFRS) for 1,387 listed firms over 2004 and 2005. We document and analyse the effects of the most significant changes from AIFRS on earnings and equity and the changes to various financial statement numbers and ratios. We find that AIFRS earnings is higher and equity is lower than AGAAP, and more firms have earnings decreases than increases. The effect on ratios is most significant for leverage where the AIFRS ratio is higher. We find little evidence that AIFRS earnings and book value are more value relevant than AGAAP earnings and book value and this result holds for partitions of industry sector, firm size and profit and loss-making firms. There is weak evidence of incremental value relevance of AIFRS accounting information.

Key words: IFRS adoption, accounting quality, account effects

* Corresponding author.

Email addresses: [email protected] (K. Ahmed), [email protected] (J. Goodwin)

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mailto:[email protected]

mailto:[email protected]

1. Introduction

This study examines the effects of Australian equivalents to International Financial

Reporting Standards (AIFRS) on the accounts of 1,387 listed entities, which is over 80 percent of

the listed firm population at January 2006. AIFRS are applicable for reporting periods beginning

after 31 December 2004, and entities are required to restate comparatives and provide

reconciliations to Australian generally accepted accounting principles (AGAAP) upon first-time

adoption. The time of initial adoption is an appropriate time for assessing the impact of this

major change in reporting rules since firms provide earnings and equity amounts measured under

two different GAAP for the same periods. We compare the AIFRS numbers with those under

AGAAP for the period immediately prior to AIFRS adoption,1 focussing on earnings and the

balance sheet.

There seems to be general agreement among commentators, the firms, analysts and the wider

community that the introduction of AIFRS will materially affect some Australian entities.2 For

example, the head of the Australasian Investor Relations Association, Mr Ian Matheson, said in

June 2005; "In some cases, the IFRS changes will have a material bearing on the companies'

reported results…” (Buffini, 2005, 6). There is no empirical evidence on this issue.

There are also different opinions on the economic consequences of AIFRS. In particular,

public opinion differs on accounting quality, cost of capital, capital raising ability and the costs

of implementation. We also examine in this paper the differences in accounting quality of

AIFRS applying a relative value relevance approach and we examine incremental value

relevance.

1 There are some standards exempt from retrospective application, namely the two financial instruments standards (AASB 132 and AASB 139), AASB 3 Business Combinations and the three insurance standards (AASB 4 Insurance Contracts, AASB 1023 General Insurance Contracts and AASB 1038 Life Insurance Contracts). 2 Consistent with this are the shareholder briefings held by some firms (e.g. Telstra and Alinta), to explain the financial impact of AIFRS on the firms accounts.

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Perhaps the loudest voice for improved quality from AIFRS is the Financial Reporting

Council (FRC) who, in 2002, claimed that the standards will enhance “the overall quality of

financial reporting in Australia” (FRC, 2002). This view is supported by the Australian

Accounting Standards Board (AASB) in a 2003 press release: “Complying with these

requirements is unlikely to impose significant burdens and costs on entities when compared with

the benefits of relevant and reliable information to users of financial reports.” (Fenton-Jones,

2003, 53). In contrast to the FRC’s view, Professors Frank Clarke and Graeme Dean of The

University of Sydney suggested in March 2005, that AIFRS will mislead investors because of the

Parliamentary Joint Committee on Corporations and Financial Services’ conclusion in February

2005, that AIFRS are Corporations Act compliant. Specifically, they argue that investors can

not rely on a firm’s accounts under AGAAP as being true and fair, since AIFRS compliant

accounts are consistent with a true and fair view (Clarke and Dean, 2005). There is no

Australian evidence on the impact of AIFRS that can shed light on the abovementioned debate

on the effect of AIFRS and its consequences for accounting quality.

One objective of this study is to investigate the effect of AIFRS on earnings and equity for

the average Australian listed firm. This is important since better predictions can be made for the

effects of AIFRS on the majority of Australian firms. Using a large sample of listed entities that

restate their earnings and equity, this paper presents the first empirical evidence on the effects of

AIFRS on the accounts and the consequences of AIFRS for financial statement quality. The

second objective is to examine the accounting quality of AIFRS earnings and book values

compared with earnings and book values prepared under AGAAP.

Jubb (2005) used the notes to the firm’s accounts in 2004 to infer the future effect of AIFRS.

The present study uses the reconciliations provided in the notes to measure the future effect of

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AIFRS. Absent any deliberate manipulation at first-time adoption and the few standards that are

exempt from restatement, we expect this comparison to provide an accurate guide of the future

effects of AIFRS on the accounts. Prior studies exploiting similar requirements use a data set

that may not be representative of the full effects of IFRS due to small sample size (Hung and

Subramanyam, 2006), or firms that voluntarily adopt AIFRS which introduces the possibility of

self-selection bias (Barth et al. 2005). The present study does not suffer from either of these

potential problems because we examine all listed firms that have available data, the exemptions

from restatement are limited to a smaller number of standards and all firms are required to restate

comparatives and provide reconciliations to AGAAP upon first-time adoption of AIFRS in

Australia (AASB 1, para 39). Our sample is over 90 percent of those currently listed firms that

were listed in 2004.

We find that the two most common adjustments to earnings are for share based payments and

income tax respectively and the two most common adjustments to equity are for income tax and

goodwill. Mean annual earnings has risen from about $38m to about $40m under AIFRS and

mean equity fallen from about $309m to about $275m under AIFRS. Medians have the same

trend. Liabilities and mean assets have increased significantly but the assets median has fallen as

has total equity. Retained earnings has also fallen although not as significantly. Operating cash

flows are unaffected. The leverage ratio shows a weaker financial position under AIFRS.

Our results do not support AIFRS earnings and book value as being more value relevant than

those of AGAAP. We find weak evidence that AIFRS information in earnings adds additional

information to information captured by AGAAP earnings and book value, but only when

predicting future operating cashflows two periods ahead. It should be noted that our main

analyses use earnings that are not always fully AIFRS compliant because some standards such as

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AASB 139 Financial Instruments, compulsory from 1 January 2005, do not have to be

retrospectively applied. Nevertheless, supplementary tests on earnings that are fully-AIFRS-

compliant provide consistent evidence for market value relevance.

The results have several implications. First, AIFRS generally shows a weaker balance sheet

suggesting that debt covenants and lending criteria may need to be addressed by account

preparers and lenders. Second, the large decline in retained earnings implies dividend-paying

capability may be reduced for some firms. Finally, if accounting numbers are an input into the

market’s cost of capital estimations, our results suggest that cost of capital may not be lower due

to AIFRS.

The paper proceeds as follows. The literature review is covered in the next section followed

by data in section 3. In section 4 we measure the effects on earnings and equity of the most

common changes from AIFRS, and report and examine differences between accounting numbers

and ratios under AGAAP and AIFRS. Section 5 covers the methodology. Empirical tests of

financial reporting quality are presented in section 6 and in section 7 we investigate the

robustness of the main results for various partitions of the data. Section 8 concludes the paper

with a summary of the major findings.

2. Literature review

Countries in the European Union moved to IFRS for reporting periods beginning after

December 31 2004, as did Australia. As a result, much of the existing research uses firms with

distinguishing economic characteristics that voluntarily adopt IFRS. For example, firms

voluntarily adopting IFRS are those seeking to access foreign capital, to improve customer

recognition or reduce political costs (El-Gazzar et al. 1999). As noted by Lang et al. (2003),

firms electing to adopt IFRS early, are more likely to be those firms with fewer reconciling

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items. How these data sets affect accounting quality comparisons is unknown. An important

difference between existing studies and this study is our data set comprises firms that must adopt

AIFRS, meaning the possible effects of self selection bias are redundant. Consequently, the

formulation of hypotheses is somewhat problematic by drawing on this literature. Further,

conflicting results in prior literature limit our ability to form confident predictions.

The most closely related studies to the present study are those that examine samples from one

country. An early paper by Kinnunen et al. (2000) exploit a unique market setting in which

foreign investors are restricted in their trading of certain shares. This permits the authors to

examine the relative value relevance of Finnish GAAP and voluntarily-adopted IAS between two

investor groups. They find IAS improves the information content for foreign investors but not

for domestic investors. Niskanen et al. (2000) also examine Finnish GAAP finding that IAS

does not have incremental value relevance. Using a price ‘levels’ regression, Dan HU (2004)

reports that Chinese GAAP is more value relevant than IAS using a sample of 252 firm years.

This finding is supported by Eccher and Healey (2003), who investigate a sample of 83 Chinese

firms that are required to provide two sets of accounts using Chinese GAAP and IFRS; finding

that earnings under Chinese GAAP are more closely associated with returns than earnings under

IFRS. They also find little difference in predictive ability of Chinese GAAP and IFRS for future

operating cash flows.

Hung and Subramanyam (2006) use a sample of 80 German firms voluntarily adopting IFRS

over the period 1998-2002 that provide accounts under German and IFRS GAAP for the same

period. Using several levels models they find that IFRS earnings are less persistent than German

GAAP earnings, and IFRS earnings and book values explain less of the variation in market price

than does German GAAP. Their results contrast with Bartov et al. (2004) who also compare

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German GAAP with IFRS (and U.S. GAAP), and find that IFRS is more value relevant than

German GAAP, but less value relevant than U.S. GAAP, using different measures of value

relevance. They also find little difference in the value relevance of U.S. GAAP earnings and

IFRS earnings. However, Bartov et al. (2004) examine firms in the cross section rather than the

same set of firms as do Hung and Subramanyam (2006). This study also examines the same

firms with the added advantage that firms must adopt AIFRS rather than voluntarily. Although

Hung and Subramanyam (2006) attempt to control for self selection bias, the possibility remains

that the bias in the IFRS accounts due to the effects of early voluntary adoptions may explain the

conflicting results, as Barth et al. (2005) have noted. Different methodology might be another

reason.

Barth et al. (2005) use data from 24 countries over a 15-year period to 2004 and find that the

transition to AIFRS results in improved accounting quality using a variety of measures.

Specifically, they find that AIFRS results in more timely recognition of losses and higher R 2s in

regressions of market value on earnings and book value. While their results may be more

representative of the overall effects of AIFRS, they are also difficult to interpret for a study

examining one country, because each set of domestic GAAP is likely different in a number of

respects. For example, the timeliness characteristic of earnings differs according to the

institutional environment between countries (Ball et al. 2000).

With respect to a country’s institutional environment, Ball et al. (2000) report that due to

different levels of conservatism, earnings of firms in common law-based countries are more

timely in impounding economic information than earnings for firms in code law countries. They

also find that earnings coefficients are larger for code law than for common law countries. Since

Australia is a common law country and Germany a code law country, the results in Hung and

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Subramanyan (2006) imply higher associations of AGAAP earnings with market value than

AIFRS and perhaps lower earnings coefficients under AGAAP ceteris paribus. Predictability of

cash flows may also be higher under AGAAP since the strength of associations of earnings with

market value and of earnings with future operating cash flows are generally positively correlated

(see Aboody et al. 1999, for example). Alternatively, because Bartov et al. (2004) report the

opposite results to that of Hung and Subramanyam (2006) using tests that are more closely

aligned with some of our tests, earnings value relevance may be lower under AGAAP than

AIFRS ceteris paribus.

The literature gives conflicting evidence on accounting quality. Our study adds to the

existing literature on the effects of adopting IFRS on earnings and equity quality, using recent

data from companies that are required at initial adoption, to provide earnings and equity numbers

under both AGAAP and AIFRS. Our evidence contributes to the ongoing debate on the alleged

superiority of IFRS.

3. Data

All firms listed on the Australian Stock Exchange were selected from Aspect Huntley Pty

Ltd’s FinAnlaysis database at January 2006 that gave a total of 1,714 firms. From these, 180

were deleted because they were listed in 2005 or 2006, 72 because they use non-Australian

GAAP or foreign currency, 73 because their accounts were not available and two because they

were delisted in 2006 and did not lodge accounts prior to delisting. Table 1, Panel A shows the

sample description. The notes to the half yearly accounts contain the restated earnings and

equity that is compared with the corresponding numbers from the accounts lodged in the prior

year, and the reconciliations to AGAAP required by AASB 1. An example reconciliation note

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for Buderim Ginger Ltd is shown in Appendix 1. The final sample comprises 1,387 firms and

the industry group breakdown is shown in Table 1, Panel B.

4. Financial statement effects of AIFRS

We examine in this section the disclosures under accounting standard AASB 1, where firms

are required to reconcile AGAAP earnings and equity to AIFRS earnings and equity, and

disclose the amounts of significant changes. AGAAP differs from AIFRS in a number of

respects. Nobes et al. (2001) reports six recognition and measurement areas where there is no

Australian standard and three for disclosure. Additionally, AGAAP is inconsistent with IFRS in

13 areas (Nobes et al. 2001). Nobes’ et al. (2001) study does not cover the pervasiveness of

these differences or their materiality however. One indicator of pervasiveness of the changeover

is the firm’s disclosures of expected effects which can be obtained from the pre-transition

disclosures. In her summary of the most disclosed significant effects of AIFRS Jubb (2005)

reports income tax is the most cited followed by share based payments. Intangibles are likely

larger and potentially their effects more material but they are also likely to be less pervasive with

about 30 percent of Australian firms capitalising intangibles (Goodwin and Ahmed, 2006). Of

course the amounts and types of significant changes and pervasiveness can only be determined

once ex-post data is available.

4.1 Reconciliations of earnings and equity

Table 2 shows the aggregated reconciliations for the last year of AGAAP earnings and for

equity at the most recent balance date that AGAAP was used. For example, for a December 31

annual balance date firm, earnings is for the year to 31 December 2004 and equity is at 31

December 2004. We select the ten most common reasons for earnings and rank from most to

least common for earnings and for equity. Equity at the most recent date is used since that is the

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earliest date that the majority of AIFRS will be applied and is the most recent of the three

reconciliation dates.3 The left half of Panel A shows the means, medians and standard deviations

for those items that have non-zero amounts, and the right half of Panel A shows that information

for all firms. The medians are all zero in the right halves of Panels A and B because about 25

percent (unreported) of firms are unaffected by AIFRS.4

4.1.1 Share-based payments

Share based payments adjustments are the most common effect on earnings at about 45 percent

of sample firms, as most firms did not recognise expenses for share options granted under

AGAAP. Application of AASB 2 Share-based Payment, reduces earnings by an average of

$1.01m (median $0.16m) and equity by $17.23m (median $1.42m). There are over six times as

many adjustments for earnings, than for equity, because recognising the expense is equity

neutral. The adjustments to equity are mainly due to elimination of receivables for employee

share schemes.

4.1.2 Income tax

The second most common adjustment to earnings is income tax and it is the most common

adjustment for the equity, with 462 or about 33 percent of sample firms reporting tax adjustments

to their earnings and 497 or about 36 percent reporting equity adjustments. The mean decrease

to earnings is $0.73m and the median increase is $0.01m for these firms. Panel B shows the

mean decrease to equity is $11.57m and the median is a $0.00m increase. The large negative

mean for equity is due to a small number of firms recognising large net deferred tax liabilities

(DTLs), due to amounts previously credited to equity such as asset revaluations. For example,

3 Specifically, AASB 139 Financial Instruments is not required to be retrospectively applied by must be applied for reporting periods beginning on or after 1 January 2005, but some firms apply the standard at the date of their last AGAAP balance sheet. 4 We measure this by firms that have a net change to earnings (net income). A firm may also be affected only by reclassification.

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one mining industry firm raised a net DTL of about $209m contributing about 87 percent of the

total change in its equity under AIFRS. A large proportion of firms, however, have a net DTA

that increases equity, giving the relatively large standard deviation of $91.66m.

4.1.3 Goodwill

For about 31 percent of our sample firms, the mean (median) goodwill adjustment to earnings is

an increase of $6.50m ($0.59m) and the mean increase to equity is $7.50m (median = $0.67m).

Under AASB 3 Business Combinations, goodwill is no longer amortised but subject to an annual

impairment test, hence the positive earnings effect. With respect to the effect on equity, changes

to amortisation carried forward are the most common reason for adjustments increasing equity.

The earnings and equity adjustments are similar because goodwill amortisation prior to transition

can not be reversed. Despite this, some firms did reverse the effects of amortisation prior to

transition.

4.1.4 Intangibles other than goodwill

There is a negative affect on earnings (mean = $1.15m) and equity (mean = $51.82m, median =

$0.25m), as a result of the tougher capitalisation tests for intangibles. The positive median for

earnings is from reversals of amortisation. AASB 138 Intangible Assets requires amounts of an

intangible nature to be expensed as incurred except for development costs and only permits

revaluations where the market is active. Further, UIG Interpretations such as UIG 1042 are more

conservative in terms of which costs can be capitalised and with respect to the amortisation

period. For example, due to its policy change to immediate expensing for customer acquisition

costs, one firm increased expenses by about $160m and decreased its equity by about $193m,

representing about 29 (100) percent of its AGAAP earnings (equity). For the equity change, the

large mean relative to the median is the result of some highly material derecognitions for a small

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number of nonfinancial firms, namely those in the media, telecommunications, food and

insurance industries.

4.1.5 Provisions

Provisions for restoration are required to be measured at the present value of expected future

payments and capitalised with the related property, plant and equipment under AASB 116 and

AASB 137. The capitalised cost is depreciated in the income statement over the assets’ lives and

the provision is acreted to the income statement as the discounted provision unwinds. These

accounting standards have caused some firms, mainly from the mining industry group to

remeasure their provisions and other firms to initially recognise such provisions. Also included

here is derecognition of general provisions.

4.1.6 Investments

Unrealised revaluation revenue on property, previously recognised directly in equity but now in

earnings, is the main reason for the large positive effect on earnings of $41.68m (median =

$0.36m). Also included in this category is the combined impact of IFRS on associates earnings

and equity. The number of adjustments to equity and the mean and median are considerably less

than for earnings because the property revaluation adjustment is equity neutral.

4.1.7 Leases

Expenses for operating leases that include fixed rental increases were previously measured as the

cash payment under AGAAP, and are measured on a straight-line basis over the lease term under

AIFRS. The retrospective adjustments to earnings and equity are negative indicating firms were

under-expensing under AGAAP. Adjustments for leases are reported by about 7 percent of

sample firms but about 35 percent of firms in the retail industries report adjustments for leases.

4.1.8 Foreign currency translation

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Foreign currency gains/losses on translation are no longer recognised in earnings as was the case

with integrated operations under AGAAP, which is the main reason for the earnings effect. Most

of these adjustments are small, hence the median of -$0.01m. The effect on equity is negative

(mean = $8.74m, median = $0.04m). Under AIFRS, nonmonetary assets for integrated

operations are now translated at the current rate, which is a common adjustment for equity.

4.1.9 Impairment

The negative effect on earnings is $3.36m (mean) and $0.03m (median). There is also a negative

effect on equity of $17.66m ($2.55m median). AASB 136 Impairment of Assets requires an asset

to be written down to its recoverable amount, which is defined as the higher of net selling price

and value in use.5 This effectively introduces a requirement to discount future cash flows to

measure recoverable amount which reduces the policy choice firms had under AGAAP. Except

for goodwill, impairment losses can be reversed through the income statement under AIFRS and

as a result some firms took large revenues in the reconciliation year. Other firms wrote back

AGAAP impairments resulting in the relatively large standard deviation for earnings.

4.1.10 Revenue

Most of the adjustments for revenue are due to firms delaying recognition under AIFRS, giving

the negative means and medians for earnings and equity. For example, following AASB 118

Revenue, a mining firm that previously recognised sales when enforceable contracts were signed

now recognises that revenue when the risks and rewards of the product have passed, thereby

reducing revenue and receivables and increasing deferred income and inventory.

4.1.11 Other

The three most common reasons within the “other” category affecting earnings are financial

instruments (78 firms), defined benefits superannuation (58) and business combinations (55).

5 Value in use is estimated fair value less cost to sell

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These three are also the most common other reasons changing equity with 115 observations for

financial instruments, 72 for defined benefits superannuation and 66 for business combinations.

Within financial instruments the main cause of the negative effects on earnings and equity is

reclassification of trust’s owners’ contributions from equity to debt, with the result that

distributions to owners are treated as an expense giving zero earnings and equity. General

Property Trusts’ equity fell by about $6.1 billion for instance. It is noteworthy that trusts are

presently amending their deeds such that reclassification from debt to equity will occur in

subsequent reporting periods. Under AIFRS firms must recognise an actuary-determined net

surplus/deficit represented by plan assets less plan obligations. Most firms did not recognise

such surpluses or deficits under AGAAP with the result that the average firm was unfunded at

the most recent balance date using AGAAP, evidenced by the negative mean adjustment of

$28.5m (median $1.7m) to equity (untabulated).

In summary, share based payments (income tax) and income tax (goodwill) are the most

common types of adjustment to earnings (equity). Of the top ten most common adjustments, the

largest mean (median) effect on earnings is attributed to investments (goodwill). The largest

mean (median) adjustment to equity of these is intangibles (revenue). The large derecognitions

for intangibles are concentrated in just a few firms hence the small medians.

4.2 Changes to financial statement elements and ratios

We next examine the effect of AIFRS on financial statement elements, retained profits,

operating cash flows and ratios. The top section of Table 3 shows that assets, liabilities and

equity differ under AIFRS, and all differences are significant at the 5 percent level. Mean total

assets has risen (p-value=0.01) yet the median has fallen (p-value=0.02), due to some very large

asset increases for a small number of firms. These increases are mainly due to first time

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consolidation of mortgage trusts by financial industry firms which has also increased liabilities

with a zero or small net equity effect. By contrast, the effect is clearly upward (downward) with

liabilities (equity), due to recognition of new liabilities, such as deferred tax liabilities for asset

revaluations and restoration provisions, remeasuring existing liabilities more conservatively,

such as defined benefit super plans and restoration provisions and reclassifications, such as

equity to debt for trusts. As noted above this latter reason is not expected in future reporting

periods because trusts are presently amending their deeds. Untabulated statistics reveal about 36

percent of firms have no change in equity from AIFRS, with about 26 percent experiencing an

increase and 38 percent a decrease.

Both the yearly and half yearly earnings have increased under AIFRS, however only the

medians are significant. Despite these trends more firms experience an earnings decrease than

an increase (39 percent versus 36 percent for annual earnings).6 This occurs because the change

to earnings is about four times larger when it is positive. The main reasons being, unrealised

gains on investments now recognised in earnings where those gains were previously taken

directly to equity and reversal of goodwill amortisation. The differences between operating

cashflows are not significantly different, which is consistent with expectations.

With respect to the ratios the differences in means are insignificant with the exception of

leverage (TL/TA). The leverage median difference is also significant and indicates higher

accounting risk under AIFRS. The ROA median is slightly higher under AIFRS and the PE ratio

lower. The PE ratio is measured only on positive earnings. The median difference of the MB

ratio is higher reflecting lower equity values. The standard deviation for the market to book ratio

is higher under AIFRS driven by highly material equity reductions mainly for large firms.

5. Accounting quality methodology

6 About 25% have no change in earnings.

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We adopt a value relevance perspective to accounting quality, recognising that it is but one of

several perspectives (Schipper and Vincent, 2003). The value relevance of earnings and book

value measured alternatively under reported AGAAP and restated AIFRS are examined, using

several models to increase confidence in the results. Following recent suggestions (Kothari and

Zimmerman, 1995) both market and non-market dependent variables are used. Use of a non-

market dependent variable avoids the criticism of endogneity levelled at regressions using

market metrics as the dependent variable (see Ronen, 2001).7 Two basic market value relevance

models and one non-market value relevance model are used.8

5.1 Relative Value Relevance

Following similar studies (e.g. Hung and Subramanyam, 2006), we use a price levels model,

which is based on Ohlson (1995).9 The model assesses the value relevance of both book value

and earnings and is shown below:

where,

7 Ronen (2001) criticises the technique of using restated accounting numbers because market value is determined, in part, by accounting numbers, thereby questioning the appropriateness of market value as a dependent variable. Others do not hold this view. Lev and Sougiannis (1996) examine the market value relevance of immediate expensing versus capitalising and amortising R&D by restating earnings using their own estimates of amortisation for example.

8 We use stock prices as proxies for the fundamental value of the firm, and examine the extent to which the alternative measurements correlate with the information set used by investors in setting stock prices (see Barth, Beaver and Landsman, 2001).9 Ohlson’s (1995) model essentially equates the value of the firm owners’ capital to its concurrent book value plus the discounted present value of the firm’s expected residual income. However, while the application of accounting based discounted present value models would normally require the forecasting of future residual income and the determination of an appropriate discount rate, this is not necessarily the case for Ohlson’s (1995) model. Ohlson rewrites the basic residual income model in terms of a weighted average of current book value and current earnings. It has been shown that these two items together with the pricing multiple applied to them, reflect the residual income forecast. This, of course, eliminates the need to estimate the future residual income. Nevertheless, data unavailability makes it impossible for us to apply Ohlson’s model in its original form. We follow, therefore, the path paved by Penman and Sougiannis (1998) and utilize realised earnings as a proxy for expected earnings.

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MV is the market value of a firm’s equity at the end of year t scaled by the number of

shares at t,

E is the firm’s earnings for year t under AGAAP or AIFRS scaled by the number of

shares at t,

BVit is the book value of equity under AGAAP or AIFRS at the end of year t scaled by

the number of shares at t, and

ε is the error term

Since inferences from the price levels model may suffer from problems of scale, all

explanatory variables are scaled by the number of outstanding shares (Barth et al. 1998; Barth

and Clinch, 2001). However, Easton (1998) and Easton et al. (2003) criticize such a procedure

arguing that it may lead to spurious results because the size of the scaler can be influenced by

management. More specifically, they suggest managers can change the number of shares

without a corresponding change in the economic characteristics of the firm.10 Accordingly we

also use a returns design.

The second model of market value relevance is the returns version of model (1). The model

is shown below:

where,

Rit is the firm’s return adjusted for capitalisation changes and dividends for the last half

of the last year that AGAAP is used,

Eit is the firm’s earnings (net income) for the last half of the last year that AGAAP is used

scaled by market value at the start of the earnings measurement interval, and

10 For example, by splitting shares or issuing bonus shares (stock dividends) which are not associated with cash flows.

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E it is the change in the firm’s earnings for the last half of the last year that AGAAP is

used scaled by market value at the start of the earnings measurement interval, and


Because earnings changes are needed model (2) can only be estimated using half-year earnings

due to lack of data.

In model (2) the coefficient of determination, coefficient estimates and their significance

levels can be used to measure combined relevance and reliability (Barth et al. 2001). Prior

research uses the sum of the coefficients from model (2), α1 + α2, to measure the persistence of

earnings, with higher values implying more persistence and better quality (Lev and Zarowin,

1999).

We also use a non-market value relevance model used by Finger (1994) that is free from the

endogeneity problem mentioned above. The model is shown below.11

where,

CFit+1 is operating cash flow for the firm one and then two half years ahead, scaled by

market value of equity at the beginning of the period,

E it is the last reported half-year earnings for the last period that AGAAP is used scaled by

the market value of equity at the beginning of the earnings measurement interval, and


Higher significance of the coefficient on E (α1) implies higher value relevance due to better

predictability (Schipper and Vincent, 2003). The future periods for the dependent variable are

the two consecutive six months periods after the last AGAAP half yearly earnings period.

Operating cash flows have not changed significantly under AIFRS for most firms, as reported in

11 Finger (1994) uses a similar model to determine the ability of cashflows and earnings to predict future cashflows.

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Table 4, and therefore can be used as a benchmark against which to evaluate the two earnings

measures. To ensure the dependent variable is independent of AIFRS effects we estimate our

regression only on those firms that report no change to operating cashflows from AIFRS.

We compare the relative value relevance of earnings and book values and earnings under the

alternative accounting regimes of AGAAP and AIFRS for firms that report a change. Our

comparison is based on examining the significance level, the relative explanatory power as

measured by the adjusted R2, and a formal test of differences in non nested models’ R2s proposed

in Vuong (1989). We first present AGAAP regressions results then AIFRS results, so Vuong’s

(1989) Z-statistic is positive when the R2 for the AIFRS regression is larger than that for the

AGAAP regression (see Dechow, 1994, Appendix 2 for further discussion).

5.2 Incremental Value Relevance

Finally, we examine the incremental value relevance of the adjustments from A- GAAP to A-

IFRS book value and earnings using the three models. These tests evaluate the ability of AIFRS

measures to reflect information beyond that in the AGAAP measurements. Model (1) is adapted

to include the additional information to earnings and to book value as follows:

where,

EDIFF is earnings under AGAAP for year t less AIFRS earnings for year t scaled by the

number of shares at t,

BVDIFF is the book value of equity under AGAAP at the end of year t less the book

value of equity under AIFRS at the end of year t scaled by the number of shares at t, and

other variables are as defined above.

19

We also adapt model (2) which uses returns as the dependent variable as follows:

where,

EDIFFit is the firm’s earnings for the last half of the last year that AGAAP is used less

AIFRS earnings for that period scaled by market value of equity at the beginning of the

earnings measurement interval,

∆EDIFFit is the change in the firm’s earnings for the last half of the last year that AGAAP

is used less the change in AIFRS earnings for that period scaled by market value of

equity at the beginning of the earnings measurement interval, and other variables are as

defined above.

In this model, a significant coefficient for α3 or α4 indicates AIFRS information is value relevant

and timely.

The non-market value relevance model (3), is also adapted as follows:

where,

EDIFFit is the last reported half-year earnings that AGAAP is used less AIFRS earnings

for that period scaled by market value of equity at the beginning of the period, and other

variables are defined above.

Table 4 presents descriptive statistics for the regression variables.

6. Results

6.1 Relative Value Relevance

20

Table 5 presents results of tests of relative value relevance of AGAAP and AIFRS

accounting numbers using prices, returns and future operating cash flows as dependent variables.

In order to control for the effect of outliers, we delete observations greater than three

standardised residuals. Panel A shows that both earnings and book value of equity are

significant under both AGAAP and AIFRS in explaining price at year end. The coefficients for

earnings and book value are each more significant under AGAAP, and the model’s explanatory

power, as measured by R2, is higher under AGAAP.12 The Vuong (1989) test indicates that the

difference in explanatory power of the equations is insignificant (p-value = 0.16).

Panel B shows results of the returns model (2) and reveals that only earnings level is

significant (and positive) in both estimated models, and the AGAAP model is more significant.

The sum of the earnings and earnings change coefficients is higher for AGAAP (0.23 versus

0.20) which is consistent with AGAAP being more permanent than AIFRS (Lev

and Zarowin, 1999). The adjusted R2s are about the same for both models.

The Vuong (1989) test reveals that this difference is insignificant (p-value =

0.73). Results of the relative ability of AGAAP and AIFRS earnings to predict future

operating cash flows are presented in Panels C and D of Table 5. Results in Panel C suggest that

AGAAP earnings better predicts future operating cash flow one-period ahead (coeff = 0.40, t-stat

= 11.98) than does AIFRS earnings (coeff = 0.36, t-stat = 11.23). It also appears that AGAAP

earnings predicts two-periods-ahead operating cash-flows better than does AIFRS earnings (t-stat

= 12.59 for AGAAP earnings and t-stat = 11.98 for AIFRS earnings) as the results in Panel D

show. The models using AGAAP numbers also explain more of the variation in future operating

cash flows than does the model using AIFRS numbers as the higher R2s indicate. However, the

Vuong (1989) tests reveal that the differences in explanatory power of the models are

12 All R2s are adjusted R2s in this paper.

21

insignificant (p-values 0.79 and 0.83 respectively). Based on the market and non

market value relevant tests, we conclude that there is no evidence that AIFRS earnings

and book value are more market value relevant than AIFRS earnings and book value.

6.2 Incremental Value Relevance

As stated earlier, incremental value relevance of AIFRS earnings and book value are

examined by including in the models, the differences between AGAAP earnings and AIFRS

earnings and AGAAP book value and AIFRS book value.

Table 6 reports the results, of incremental value relevance and Panel A shows that both

earnings and book value of equity under AGAAP are significant, which is consistent with Table

5. The additional information in AIFRS earnings is not value relevant as the EDIFF coefficient

results indicate (t-stat = 0.70). The net book value adjustment under AIFRS is also insignificant

(t-stat = -1.59). Panel B reports results of the returns model assessing the timeliness and value

relevance of the additional AIFRS earnings information and reveals that neither of the two

coefficients for the extra information in earnings (EDIFF) and earnings change (ΔEDIFF) are

significant. The earnings and earnings change coefficients for AGAAP, adjusted R2 and

significance are similar to those in Table 5, Panel B. Panels C and D report results from the non-

market value relevance model and show that the coefficients for the incremental information in

earnings are both negative and one is significant, namely for two year ahead cashflows (t-stat = -

3.25). Recall that we measure the increments as AGAAP less AIFRS, and therefore a negative

coefficient for EDIFF indicates that the extra information in AIFRS earnings is positively

associated with future operating cashflows.

22

Considering all results together, there is weak evidence that AIFRS earnings is incrementally

value relevant information to AGAAP. We find no evidence supporting incremental value

relevance for the extra information in book value under AIFRS.

7. Additional Analyses

7.1 Firm Size

Predictions of a lower the cost of capital from using IFRS principally relate to large firms

because they are more likely to be cross-listed and to seek capital from overseas. A lower cost of

capital may be associated with higher accounting quality. Additionally, the materiality of AIFRS

adjustments varies with firm size, where firm size is measured using total assets. Unreported

statistics reveal that large firms experience an increase in net income while small firms

experience a decrease and large firms have a decrease in equity while small firms have no

change. The main reason for the earnings differences is that writedowns of intangibles and

recognition of share based payments expense while pervasive across firm sizes are more material

in small firms. Recognition of unrealised investment gains in earnings and reversal of goodwill

amortisation are each about six times more common in large firms than in small firms. The

negative adjustments to equity for unfunded superannuation plans, employee loans under share

schemes, reclassifications of equity to debt and intangible writedowns are more common in large

firms.

Table 7 shows results from the four regressions estimated for trichotomies based on total

assets at the end of the last year that used AGAAP. Of the twelve estimated regressions seven

are more significant for the AGAAP sample. However, none of the Vuong (1989) Z-statistics

are significant suggesting no difference in accounting quality between AGAAP and AIFRS

across size groups.

23

7.2 Industry

Evidence also suggests the may be an industry effect for AIFRS on accounting quality. For

example, unreported statistics reveal initial recognition of restoration provisions are more

common in non-financial and remeasurement of those provisions common in the mining sector,

investment unrealised gains and losses in earnings is about three times as common in financial

than the other sectors, and the intangible adjustments are about twice as common across the non-

financial sector than either of the other two sectors. Prior research in Australia has found that the

value relevance of the upward revaluations of non-current assets differs across industries (Barth

and Clinch, 1998).

We present in Table 8, results from estimating the four regressions for mining, financial and

non-financial industry groups, where the specific industries in these groups are shown in table 1,

Panel B. Of the twelve estimated regressions eight are more significant for the AGAAP sample.

However, in contrast to the size tests above, one of the Vuong (1989) Z-statistics is significant at

the 10 percent level, namely for the price levels model (Panel A) for the Financial group. This

suggests that AGAAP earnings and book value are more value relevant than AIFRS earnings and

book value.

7.3 Loss-Makers

Loss-making firms may affect our inferences. Specifically, it is possible the comparisons of

market value relevance between the two samples are affected by different numbers or materiality

of losses, since R2s and ERCs from returns-earnings regressions are lower for loss-making firms

(Hayn, 1995). Additionally, a more timely recognition of economic losses from initial

recognition of provisions and the more stringent asset impairment test under AIFRS, may result

higher quality of earnings under AIFRS.

24

The four regressions are estimated on profit only and loss only sub-samples and the results

reported in Table 9. The AGAAP regression is more significant than the AIFRS regression for

all of the profit samples, and for one of the loss samples as indicated by the negative signs on

Vuong’s (1989) Z-statistic. However, no difference in explanatory power is significant. The

most significant difference is for the profit sample and the price-per-share regression (Z-stat = -

1.59), indicating that AGAAP is more value relevant than AIFRS at the 11 percent level (two-

tailed test). One concludes that AIFRS is not more value relevant than AGAAP for profit or loss

making firms.

7.4 Other Specification Checks

We carry out additional checks on our main results in Table 5. First, we estimated all

equations using rank regression on the untrimmed sample to examine the effect of outliers on our

analyses. Results are qualitatively similar to the full sample results in Table 5, except for the

returns model, where the R2 for the AIFRS equation is 0.17 and it is 0.16 for the AGAAP

equation. However, the difference is insignificant (Z-stat = 0.12).

We also estimated annual returns measured to reporting date and then to three months after

reporting date, on earnings levels for annual (restated) earnings with the same inference as for

the returns model in Table 5, Panel B. We replicated the price levels regression using prices

measured at three months after reporting date with qualitatively similar results to those in Panel

A of Table 5.

Because the restated earnings are not fully AIFRS compliant, we examine fully-compliant

half-yearly earnings for 2005 or 2006 compared with the previous corresponding period in 2004

or 2005, by estimating returns on earnings. A constant sample of 1,050 firms is used to control

for differences in the mix of industry and size, although the analysis introduces unavoidable time

25

series variation. There is a larger sample compared with the returns model in Table 5 because

the main tests were on firms only with a change in earnings. Both equations are insignificant and

the Vuong (1989) Z-statistic is -0.72 which is also insignificant. When we examine only profit

firms the AIFRS earnings is more significant than AGAAP earnings in explaining

contemporaneous returns but the difference in explanatory power is insignificant (p = 0.97).

8. Conclusion

This paper provides evidence on the effects of IFRS on the accounts and accounting quality

for a large sample of Australian firms. There is little doubt about representativeness of the

results because over 80 percent of the currently listed firm population is examined. The results

supplement prior studies because we reconcile from a data set of pre-IFRS GAAP that is more

liberal and not conservative and our data set comprises firms that must apply AIFRS.

Consequently, this study provides a different perspective of the effects of AIFRS because the

potential effects of self selection bias are absent.

AIFRS adjustments are found to increase mean and median earnings and to decrease mean

and median equity. Unrealised gains on investment property, reversal of goodwill amortisation

are the main drivers of earnings increases. Revenue recognition and impairment are the major

drivers of equity decreases for the average firm. Write downs of intangibles and reclassifications

of equity to debt reduced equity substantially but those adjustments are not pervasive.

Little evidence is found that AIFRS earnings and book value are more value relevant than

AGAAP earnings and book value, using regressions with both market and non-market dependent

variables consistent with most studies comparing within country (Dan HU 2004, Eccher and

Healey, 2003 and Hung and Subramanyam, 2006). These results hold across subsamples based

on firm size, industry sector, and profit and loss making firms. We also find that AIFRS adds

26

additional information to that captured by AGAAP earnings only in predicting future operating

cashflows for two periods ahead. Adjustments to book value under AIFRS are not value

relevant. In sum, we find no conclusive evidence that AIFRS has improved the quality of

accounting information for the average listed Australian firm.

We acknowledge two unavoidable limitations. First, our main tests use a data set that is not

fully AIFRS compliant. Supplementary tests on one period of fully compliant earnings do

provide consistent evidence, but inferences may change when more periods of fully-compliant

data become available. Second, as with all studies using this approach, (see for example, Lev

and Sougiannis, 1996 and Bryant, 2003), our market value relevance tests assume price would be

unchanged if AIFRS information had been released prior to the price measurement date.

Acknowledgments: We acknowledge the helpful comments of workshop participants at the October 2005 Emerging Issues Discussion Group at the Australian Accounting Standards Board, 2006 AAA conference in Washington D.C., AFAANZ 2006 conference in Wellington, Monash University and RMIT University and Max Aiken, Richard Heaney, Erik Hopp and Alex Martin. Any errors remain the authors’ responsibility.

27

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Appendix 1Case 1: Excerpts from the notes to the group accounts in Buderim Ginger Ltd 2005 half-yearly

report

(e) Impact of adoption of AIFRS The impact of adoption of AIFRS on the total equity and profit after tax as reported under Australian Accounting Standards applicable before 1 January 2005 (‘AGAAP’) are illustrated below.

(i) Reconciliation of total equity as presented under AGAAP to that under AIFRS

CONSOLIDATED31-Dec-04 30-Jun-04 1-Jan-04

$’000 $’000 $’000Total equity under AGAAP 22,662 18,453 18,129Adjustments to equityAdjustment to employee entitlements A 1 3 2Write-back of general doubtful debt provision B 14 10 11Write-back of trademark amortisation C 21 10 -Write-back of goodwill amortisation D 42 4 -Adjustment to foreign currency translation reserve E (34) 70 -Tax effect of the above adjustments F (5) (4) (4)Tax effect on asset revaluation reserve G (246) (246) -Total equity under AIFRS 22,454 18,300 18,138

(A) The expected outflow of long term annual and sick leave entitlements has been discounted and provisions adjusted accordingly under AASB 119 'Employee Benefits'. Discounting of long service leave entitlements only was performed under AGAAP.

(B) Only specific debts identified as doubtful are to be shown in a provision under AIFRS whereas general doubtful debt provisions were provided under AGAAP.

(C) Trademarks are not amortised under AASB 138 'Intangible Assets', but were amortised under AGAAP.

(D) Goodwill is not amortised under AASB 3 'Business Combinations', but was amortised under AGAAP.

(E) Under AGAAP a number of the Group’s overseas subsidiaries were classified as integrated, and were translated using the temporal method, with translation gains or losses reported in the profit or loss. Under AIFRS the financial statements of overseas subsidiaries that sell in their local currency, are translated at the spot rate at the end of the reporting period, and income statement items translated at the weighted average

(F) The tax effect of the adjustments above (note (A) to (E)) in accordance with AASB 112 'Income Taxes' led to a decrease in the deferred tax asset.

(G) A portion of the asset revaluation reserve of $820,000 recognised under AGAAP has been tax-effected on transition to AIFRS under AASB116 ‘Property, Plant and Equipment’ at the tax rate of 30%.

31

CONSOLIDATEDFor the Year

ended31-Dec-04

For the HalfYear ended30-Jun-04

Profit after tax as previously report 293 (389)Adjustment to employee entitlements (2) -Write-back of general doubtful debt provision 3 1Write-back of trademark amortisation 21 10Write-back of goodwill amortisation 42 4Adjustment to foreign currency translation reserve 166 66Net adjustment to tax expense (1) -Profit after tax under AIFRS 522 (308)

(iii) Explanation of material adjustments to the cash flow statements There are no material differences between the cash flow statements presented under AIFRS and those presented under AGAAP.

Table 1Sample Descriptive StatisticsPanel A – Description of SampleNumber of firms listed on ASX at January 2006 1,714LessFirms listed in 2005 or 2006 180Firms using foreign currency / foreign GAAP 72Accounts not available 73Firms delisted in 2006 2Final sample 1,387

Panel B: Sample Firms by Industry Group N Percentage

Energy 93 6.7%Materials 392 28.3%

Total Mining 485 35.0%Banks 14 1.0%Diversified Financials 143 10.3%Insurance 8 0.6%Real Estate 88 6.3%

Total Financial 253 18.2%Automobiles & Components 10 0.7%Capital Goods 81 5.8%Commercial Services & Supplies 49 3.5%Consumer Durables & Apparel 19 1.4%Consumer Services 33 2.4%Food & Staples Retailing 7 0.5%Food, Beverage & Tobacco 39 2.8%Health Care Equipment & Services 60 4.3%Hotels Restaurants & Leisure 6 0.4%Media 42 3.0%Pharmaceuticals & Biotechnology 75 5.4%

32

Retailing 35 2.5%Semiconductors & Semiconductor Equipment 2 0.1%Software & Services 87 6.3%Technology Hardware & Equipment 36 2.6%Telecommunication Services 29 2.1%Transportation 22 1.6%Utilities 17 1.2%

Total Nonfinancial 649 46.8%Total 1,387 100.0% 100.0%

33

Table 2Effect of Most Significant Items on Earnings and Equity

Observations with non-zero amounts All Observations

Mean Median Std Dev N Mean Median Std Dev

Panel A: EarningsAGAAP 37.65 -0.10 249.42 1,384 37.65 -0.10 249.42

Share Based Payments -1.01 -0.16 5.25 624 -0.45 0.00 3.55Income Tax -0.73 0.01 19.96 462 -0.24 0.00 11.54Goodwill 6.50 0.59 35.07 426 2.00 0.00 19.65Intangibles -1.15 0.03 13.65 182 -0.15 0.00 4.95Provisions -0.39 -0.05 2.41 166 -0.05 0.00 0.84Investments 41.68 0.36 248.51 135 4.06 0.00 78.25Leases 0.11 -0.05 4.42 98 0.01 0.00 1.17FX Translation -1.94 -0.01 19.07 95 -0.13 0.00 4.99Impairment -3.36 -0.03 23.39 94 -0.23 0.00 6.12Revenue -5.23 -0.27 19.18 68 -0.26 0.00 4.36Other -9.25 -0.05 77.75 324 -2.16 0.00 37.74

AIFRS 40.04 -0.06 252.51 1,384 40.04 -0.06 252.51

Panel B: Equity

AGAAP 308.72 15.31 1,652.69 1,387 308.72 15.31 1,652.69Income Tax -11.57 0.00 91.66 497 -4.14 0.00 55.11Goodwill 7.50 0.67 40.26 421 2.28 0.00 22.43Intangibles -51.82 -0.25 296.94 204 -7.62 0.00 115.11Provisions -2.50 -0.20 11.79 182 -0.33 0.00 4.34Share Based Payments -17.23 -1.42 40.39 97 -1.20 0.00 11.50Impairment -17.66 -2.55 37.98 122 -1.55 0.00 12.29Leases -4.80 -0.27 17.81 98 -0.34 0.00 4.87Investments -0.51 -0.13 57.26 96 -0.04 0.00 14.99FX Translation -8.74 -0.04 52.75 87 -0.55 0.00 13.31Revenue -23.08 -2.78 95.41 70 -1.16 0.00 21.88Other -75.36 -0.26 539.01 359 -19.51 0.00 275.92

AIFRS 274.55 14.28 1,504.23 1,387 274.55 14.28 1,504.23Notes: Earnings is measured for the last financial year that AGAAP is used, Equity is net assets measured at the end of the last financial year that AGAAP is used. There are a different number of observations for equity than for net income because some firms did not provide particular reconciliations.

34

Table 3Effect of AIFRS on Financial Statement Numbers and Ratios

Mean Median Standard deviation

N AGAAP AIFRS t-test AGAAP AIFRS Wilcoxon AGAAP AIFRS F-test

Total Assets 1,386 1,614.76 1,675.39 0.01 22.95 22.63 0.02 18,152.14 18,570.75 0.40

Total Liabilities 1,386 1,305.84 1,400.72 0.00 5.20 5.59 0.00 16,712.94 17,250.69 0.24

Total Equity 1,387 308.72 274.55 0.00 15.31 14.28 0.00 1,652.69 1,504.23 0.00

Retained Profits 1,384 61.45 54.50 0.11 -3.66 -4.23 0.00 653.20 608.90 0.01

Earnings 1,384 37.65 40.04 0.13 -0.10 -0.06 0.02 249.42 252.51 0.65

Earnings - Half Year 1,377 19.80 20.03 0.82 -0.01 0.00 0.00 133.81 128.67 0.15

Cash flows – Half Year 1,367 20.31 7.38 0.22 -0.13 -0.14 0.23 233.03 246.36 0.04

ROE 1,371 -0.30 -0.29 0.73 0.00 0.01 0.59 5.08 5.12 0.75

ROA 1,382 -0.32 -0.32 0.30 -0.01 -0.01 0.03 3.15 3.15 0.99

TL / TA 1,385 0.54 0.57 0.00 0.29 0.31 0.00 3.46 3.47 0.94

Price earnings 609 21.53 19.10 0.30 11.17 10.64 0.00 47.21 59.80 0.00

Market to book 1,351 3.12 2.90 0.47 1.71 1.82 0.00 20.32 22.76 0.00

Notes: Cash flows = operating cash flows, All balance sheet numbers are measured at the end of the last financial year reported under AGAAP, All financial statement numbers are expressed in millions, ROE = earnings divided by equity at year end, ROA = annual earnings divided by total assets at financial year end, TL = total liabilities, TA = total assets, Price earnings ratio is calculated only for positive earnings for both AGAAP and AIFRS, T here are more equity observations than assets and liabilities because one firm provided an equity reconciliation and did not disclose assets and liabilities p-values are for two-tailed tests

35

Table 4Descriptive Statistics for AGAAP and AIFRS Regression VariablesVariable N Mean Median Std Dev Min Max

Dependent Variables

MVit 1,020 1.21 0.46 1.73 0.00 8.86

Rit 980 -0.07 -0.07 0.32 -0.83 1.17

CFit+1 713 0.02 0.02 0.14 -0.78 0.61

CFit+2 725 -0.01 0.01 0.15 -1.04 0.46

Independent Variables – Incremental Tests

EDIFFit(MV) 1,020 0.00 0.00 0.08 -0.82 0.79

BVDIFF it(MV) 1,020 0.08 0.00 0.38 -1.10 5.08

EDIFFit(R) 980 0.00 0.00 0.06 -0.66 0.45

∆EDIFFit(R) 980 0.00 0.00 0.07 -0.68 0.55

EDIFFit(CF1) 713 0.00 0.00 0.07 -1.28 0.42

EDIFFit(CF2) 725 0.00 0.00 0.10 -1.38 1.41

Independent Variables – Relative Tests

AGAAP AIFRSVariable N Mean Median Std Dev Min Max Mean Median Std Dev Min Max

Eit(MV) 1,020 0.06 0.00 0.19 -1.42 3.01 0.06 0.00 0.19 -1.02 3.00

BVit(MV) 1,020 0.75 0.24 1.15 -0.56 8.65 0.67 0.22 1.05 -0.79 8.65

Eit(R) 980 -0.03 0.01 0.20 -1.72 3.43 -0.02 0.01 0.20 -1.73 3.43

∆Eit(R) 980 -0.02 0.00 0.22 -1.69 3.44 -0.02 0.00 0.22 -1.69 3.58

Eit(CF1) 713 0.00 0.02 0.14 -0.97 1.36 0.01 0.02 0.15 -0.98 1.38

Eit(CF2) 725 0.00 0.02 0.16 -1.38 1.36 0.00 0.02 0.18 -1.78 1.38

Dependent Variables: MV is the market value of a firm’s equity at the end of year t scaled by the number of shares at t, R it is the firm’s raw return adjusted for capitalisation changes and dividends for the last half of the last year that AGAAP is used, CF it+1 is operating cash flow for the firm one half year ahead, scaled by market value of equity at the beginning of the earnings measurement interval, CF it+2 is operating cash flow for the firm two half years ahead, scaled by market value of equity at the beginning of the earnings measurement interval, Independent variables - incremental tests:EDIFF(MV) is earnings under AGAAP for year t less AIFRS earnings for year t scaled by the number of shares at t, BVDIFF(MV) is the book value of equity under AGAAP at the end of year t less the book value of equity under AIFRS at the end of year t scaled by the number of shares at t, EDIFFit (R)is the firm’s earnings for the last half of the last year that AGAAP is used less AIFRS earnings for that period scaled by market value of equity at the beginning of the earnings measurement interval, ∆EDIFF it (R)is the change in the firm’s earnings for the last half of the last year that AGAAP is used less the change in AIFRS earnings for that period scaled by market value of equity at the beginning of the earnings measurement interval, EDIFFit (CF) is the last reported half-year earnings that AGAAP is used less AIFRS earnings for that period scaled by market value of equity at the beginning of the period, Independent Variables - relative tests:E(MV) is the firm’s earnings for year t under AGAAP or AIFRS scaled by the number of shares at t, BV it(MV)is the book value of equity under AGAAP or AIFRS at the end of year t scaled by the number of shares at t, E it(R) is the firm’s earnings (net income) for the last half of the last year that AGAAP is used scaled by market value at the start of the earnings measurement interval, ER it is the change in the firm’s earnings for the last half of the last year that AGAAP is used scaled by market value at the start of the earnings measurement interval, Eit(CF) is the last reported half-year earnings for the last period that AGAAP is used scaled by the market value of equity at the beginning of the earnings measurement interval.

36

Table 5Results from Relative Value Relevance under AGAAP and AIFRS

Panel A: Price as dependent variable. N = 1,020

Constant t E t BV t R2 F-statVuong Z-stat

(p-value)

AGAAP 0.34 9.32 2.02 10.36 1.01 31.23 0.68 1,071.82 -1.42(0.16)AIFRS 0.39 10.05 2.05 9.21 1.03 25.06 0.62 838.13

Panel B: Returns as dependent variable. N = 890

Constant t E t ∆E t

AGAAP -0.06 -5.90 0.38 5.43 -0.15 -2.38 0.03 15.93 -0.35(0.73)AIFRS -0.06 -6.05 0.36 5.23 -0.16 -2.52 0.03 14.42

Panel C: Operating cash flows one period ahead as dependent variable. N=713

Constant t E t

AGAAP 0.02 3.82 0.40 11.98 0.17 143.69 -0.26(0.79)AIFRS 0.02 3.53 0.36 11.23 0.15 126.23

Panel D: Operating cash flows two periods ahead as dependent variable. N=725

AGAAP -0.01 -1.33 0.40 12.59 0.18 158.68 -0.22(0.83)AIFRS -0.01 -1.49 0.35 11.98 0.16 143.44

Notes: Two-tailed t-statistics in brackets, E is AGAAP or AIFRS annual earnings in panels A, B and C. BV is book value of AGAAP equity and AIFRS equity at the end of the year. All variables are scaled by the number of shares at the end of the year in panel B and by book value of equity at the start of the year in panel C. E is the half year AGAAP or AIFRS earnings for the last year that AGAAP is used scaled by market value of equity at the start of the period in Panel D. ∆E is change in earnings for the last-half of the last year that AGAAP is used scaled by market value of equity at start of the period in Panel D. E is the last reported half-year earnings scaled by market value of equity at start of period in Panels E and F. p-values are from two-tailed tests.

37

Table 6Results From Incremental Value Relevance of AIFRS Earnings and Book Value

Constant E BV EDIFF BVDIFF R2 F-statistic

Panel A: Price scaled by number of shares as dependent variable. N = 1,020

0.33 1.96 1.04 0.30 -0.150.67 536.87

(9.03) (9.42) (27.26) (0.70) (-1.59)


E ∆E EDIFF ∆EDIFF

-0.06 0.38 -0.15 0.07 0.010.03 8.00

(-5.86) (5.38) (-2.36) (0.23) (0.01)

Panel C: Operating cashflows one period ahead as dependent variable. N = 713

E EDIFF

0.02 0.40 -0.090.17 72.69

(3.74) (12.05) (-1.25)

Panel D: Operating cashflows two periods ahead as dependent variable. N = 725-0.01 0.42 -0.16

0.19 85.67(-1.38) (13.02) (-3.25)

Notes: E is annual AGAAP earnings, BV is book value of AGAAP equity at the end of the year, EDIFF is AGAAP annual earnings less AIFRS annual earnings in Panels A, B and C, BVDIFF is AGAAP book value of equity at the end of the year less AIFRS book value of equity at the end of the year. All variables are scaled by the number of shares at the end of the period in panel B and by AGAAP book value of equity at the beginning of the period in Panel C. E is the half year AGAAP or AIFRS earnings for the last year that AGAAP is used scaled by market value of equity at the start of the period in Panel D. ∆E is change in earnings for the last-half of the last year that AGAAP is used scaled by market value of equity at start of the period in Panel D. EDIFF is AGAAP half year earnings less AIFRS half year earnings for the last-half of the last year that AGAAP is used scaled by market value of equity at start of the period in Panel D. E is the last reported half-year earnings scaled by market value of equity at start of period in Panels E and F.

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Table 7Results from Relative Value Relevance under AGAAP and AIFRS for Firm Sizes



(p-value)

LargeN = 340

AGAAP 0.86 7.09 1.88 5.97 0.86 14.62 0.54 199.10 -1.17(0.24)AIFRS 1.08 8.48 1.83 5.13 0.82 11.39 0.46 147.73

MediumN = 340

AGAAP 0.35 6.62 2.33 5.32 0.87 9.83 0.39 109.48 -0.54(0.59)AIFRS 0.39 7.05 2.55 5.43 0.82 7.79 0.35 92.37

SmallN = 340

AGAAP 0.05 3.03 -0.70 -2.58 1.44 17.52 0.47 153.59 0.06(0.95)AIFRS 0.04 2.68 -0.73 -2.51 1.59 17.51 0.48 155.05



LargeN = 296

AGAAP 0.03 2.64 0.41 2.58 0.17 0.86 0.03 6.12 0.01(0.99)AIFRS 0.04 3.09 0.18 1.33 0.29 1.67 0.03 6.18

MediumN = 297

AGAAP -0.06 -3.36 0.33 1.83 0.21 1.04 0.04 6.78 -0.04(0.97)AIFRS -0.06 -3.45 0.40 2.09 0.20 0.94 0.04 6.67

SmallN = 297

AGAAP -0.17 -8.03 0.13 1.37 -0.08 -1.02 0.01 0.95 0.11(0.91)AIFRS -0.17 -8.11 0.13 1.38 -0.10 -1.29 0.01 1.06

Panel C: Operating cash flows one period ahead as dependent variable. N = 713

Constant t E t

LargeN = 237

AGAAP 0.07 9.06 0.05 0.74 -0.01 0.55 -0.14(0.89)AIFRS 0.07 9.16 0.03 0.40 -0.01 0.17

MediumN = 238

AGAAP 0.03 2.49 0.31 4.62 0.08 21.39 0.27(0.79)AIFRS 0.02 2.32 0.34 5.32 0.10 28.31

SmallN = 238

AGAAP -0.01 -1.43 0.43 8.38 0.23 70.34 -0.51(0.61)AIFRS -0.02 -2.65 0.31 6.63 0.15 43.95

Panel D: Operating cash flows two periods ahead as dependent variable. N = 630

LargeN = 241

AGAAP 0.03 3.33 0.16 1.91 0.01 3.63 -0.22(0.83)AIFRS 0.03 4.11 0.08 1.31 0.01 1.72

MediumN = 242

AGAAP 0.01 0.82 0.40 6.24 0.14 38.98 -0.35(0.73)AIFRS 0.01 0.85 0.36 5.67 0.12 32.18

SmallN = 242

AGAAP -0.05 -5.27 0.32 6.66 0.15 44.33 0.29(0.77)AIFRS -0.05 -5.76 0.32 7.69 0.20 59.23

Notes: E is AGAAP or AIFRS annual earnings in panel A. BV is book value of AGAAP equity and AIFRS equity at the end of the year. All variables are scaled by the number of shares at the end of the year in panel A. E is the half year AGAAP or AIFRS earnings for the last half of the last year that AGAAP is used scaled by market value of equity at the start of the period in Panel B. ∆E is the change in earnings for the last-half of the last year that AGAAP is used scaled by market value of equity at start of the period. E is the half-year AGAAP or AIFRS earnings for the last period of the last reported half year earnings under AGAAP scaled by market value of equity at start of period in Panels C and D. Two-tailed t-statistics in brackets, p-values are from two-tailed tests.

39

Table 8Results from Relative Value Relevance under AGAAP and AIFRS for Industry Groups



(p-value)

MiningN = 321

AGAAP 0.23 4.42 0.90 3.54 1.21 19.80 0.70 370.58 0.30(0.76)AIFRS 0.18 3.60 0.45 1.78 1.53 21.66 0.72 412.74

FinancialN = 184

AGAAP 0.33 2.99 5.84 9.89 0.51 7.44 0.64 164.46 -1.63(0.10)AIFRS 0.62 4.79 4.72 6.55 0.38 3.74 0.47 82.67

Nonfinancial

N = 515AGAAP 0.34 7.10 1.78 6.19 1.18 26.45 0.73 699.39 -0.91

(0.36)AIFRS 0.41 7.79 2.54 7.49 1.12 20.15 0.69 560.29



MiningN = 255

AGAAP 0.01 0.19 0.92 4.20 -0.35 -1.79 0.07 11.36 -0.19(0.85)AIFRS 0.01 0.13 0.88 4.21 -0.42 -2.14 0.07 10.50

FinancialN = 171

AGAAP -0.01 -0.55 0.30 2.09 -0.26 -1.64 0.01 2.20 -0.05(0.96)AIFRS -0.01 -0.51 0.24 1.73 -0.09 -0.66 0.01 2.03

Nonfinancial

N = 464AGAAP -0.11 -7.42 0.29 3.41 -0.11 -1.52 0.02 6.08 -0.40

(0.69)AIFRS -0.11 -7.56 0.26 3.17 -0.12 -1.69 0.02 5.06


Constant t E t

MiningN = 185

AGAAP 0.01 0.57 0.63 8.99 0.30 80.89 0.28(0.78)AIFRS 0.01 1.10 0.62 9.85 0.34 97.04

FinancialN = 124

AGAAP 0.03 3.08 0.08 0.96 -0.01 0.91 0.31(0.76)AIFRS 0.03 2.80 0.13 1.86 0.02 3.44

Nonfinancial

N = 404AGAAP 0.02 3.87 0.38 8.92 0.16 79.53 -0.63

(0.53)AIFRS 0.02 3.32 0.29 7.15 0.11 51.09


MiningN = 187

AGAAP -0.02 -2.46 0.50 9.21 0.31 84.85 -0.03(0.98)AIFRS -0.02 -2.11 0.42 9.08 0.30 82.37

FinancialN = 128

AGAAP 0.02 1.82 0.10 1.19 0.01 1.43 0.35(0.73)AIFRS 0.02 1.61 0.17 2.27 0.03 5.14

Nonfinancial

N = 410AGAAP -0.01 -0.34 0.39 8.58 0.15 73.61 -0.54

(0.59)AIFRS -0.01 -0.82 0.31 7.23 0.11 52.25


40

Table 9Results from Relative Value Relevance under AGAAP and AIFRS for Profit and Loss Making Firms

Panel A: Price as dependent variable. N = 982


(p-value)

ProfitN=518

AGAAP 0.45 6.04 3.04 9.62 0.86 18.15 0.63 438.43 -1.59(0.11)AIFRS 0.56 6.92 3.01 8.40 0.82 13.80 0.55 322.38

Loss N=464

AGAAP 0.09 4.44 -0.02 -0.13 1.54 25.14 0.64 410.63 -0.06(0.95)AIFRS 0.08 3.33 -0.69 -3.19 1.59 26.00 0.64 407.51



Profit N=460

AGAAP 0.01 0.11 0.61 3.51 -0.55 -3.12 0.02 6.18 -0.04(0.97)AIFRS 0.01 0.01 0.58 3.46 -0.51 -3.01 0.02 6.03

LossN=379

AGAAP -0.18 -8.47 0.02 0.18 -0.03 -0.47 -0.01 0.11 0.11(0.91)AIFRS -0.19 -8.82 -0.01 -0.16 -0.04 -0.59 -0.01 0.31


Constant t E t

Profit N=412

AGAAP 0.06 9.47 0.11 2.05 0.01 4.12 -0.43(0.67)AIFRS 0.07 9.70 0.07 1.36 0.01 1.84

Loss N=274

AGAAP -0.02 -2.46 0.38 6.92 0.15 47.92 0.38(0.70)AIFRS -0.02 -2.16 0.39 7.27 0.16 52.83


Profit N=414

AGAAP 0.04 4.82 0.13 2.14 0.01 4.59 -0.68(0.50)AIFRS 0.04 5.02 0.09 1.55 0.01 2.41

Loss N=280

AGAAP -0.04 -3.85 0.43 7.94 0.18 63.11 0.63(0.53)AIFRS -0.04 -3.77 0.44 9.73 0.25 94.66


41