THE RELATIONSHIP BETWEEN IFRS

AND DEVELOPMENT IN DEVELOPING

COUNTRIES

Word count: 22856

Stijn Vanparys Student number: 01402683

Supervisor: Prof. Dr. Ignace De Beelde

Master’s Dissertation submitted to obtain the degree of:

Master of Science in Business Economics

Academic year: 2017 – 2018

THE RELATIONSHIP BETWEEN IFRS

AND DEVELOPMENT IN DEVELOPING

COUNTRIES

Word count: 22856

Stijn Vanparys Student number: 01402683

Supervisor: Prof. Dr. Ignace De Beelde

Master’s Dissertation submitted to obtain the degree of:

Master of Science in Business Economics

Academic year: 2017 – 2018

I

Confidentiality Agreement

PERMISSION

I declare that the content of this Master’s Dissertation may be consulted and/or reproduced, provided that the

source is referenced.

Name student : Stijn Vanparys

Signature

II

Foreword

Writing this Master Dissertation taught me a lot about academic (literature) research. I chose this subject because I

am very interested in the impact that accounting can have on development. These subjects are often seen as two

completely different things, but are in fact interesting to research in combination.

However, I could not have accomplished this thesis without help from other people.

First, I would like to thank my promotor, Prof. Dr. Ignance De Beelde, who helped me through the process with

guidelines and he was always ready to answer my questions.

Furthermore, I would like to thank Silke Vanparys to proofread the paper and make some spelling adjustments.

Finally, I would like to thank my friends and family for all the support I got throughout the process of writing this

thesis.

Stijn Vanparys

III

Summary in Dutch

In deze Masterproef wil ik een antwoord geven op de vraag: ‘Kan het toepassen van IFRS ontwikkelingslanden

helpen in hun verdere ontwikkeling?’ a.d.h.v. een uitgebreid literatuuronderzoek. Eerst bespreek ik de

geschiedenis van IFRS en de huidige situatie. Met IFRS probeert de IASB accounting regels over de wereld zoveel

mogelijk te harmonizeren met als doelstelling o.a. hoge accounting kwaliteit en vergelijkbaarheid wereldwijd. Met

de sterke verspreiding van IFRS over ondertussen 144 landen kennen de standaarden een groot succes.

Daarna bespreek ik de relatie tussen accounting en ontwikkeling. Uit onderzoek blijkt dat accounting wel degelijk

een belangrijke rol speelt in ontwikkeling, hierdoor zetten organisaties zoals de United Nations (bv. via hun

Sustainable Development Goals) en de World Bank sterk in op goeie accounting voor ontwikkelingslanden. Het

vervolg van de masterproef focust zich op de rol van IFRS in deze relatie.

IAS 41 over de landbouwindustrie is een belangrijke IFRS standaard voor veel ontwikkelingslanden. Uit het meeste

academisch onderzoek blijkt dat de landbouwindustrie vaak een belangrijke rol speelt in verdere ontwikkeling

(mestal als opstap naar de industrializering in die landen) en de meeste ontwikkelingslanden nog steeds sterk

afhankelijk zijn van de industrie. Helaas blijkt dat IAS 41 nog heel wat gebreken heeft waardoor de bijdrage aan

ontwikkeling beperkt zal blijven en oudere landbouwstandaarden hiervoor misschien eerder aan te raden zijn.

Verder heb ik de factoren die een land er toe aanzetten om voor full IFRS te kiezen besproken a.d.h.v. 2 belangrijke

papers op dit vlak. Deze factoren kunnen bellangrijke informatie bevatten voor landen in hun

implementatiebeslissing en de IASB in voor hun werkpunten.

De belangrijkste voordelen die IFRS kan leveren zijn versterkte accounting kwailiteit en verhoogde investeringen

vanuit het buitenland. Beiden zijn echter sterk afhankelijk van andere factoren zoals wettelijke en politieke

systemen, financiele markten en kapitaalstructuur. Vooral deze wettelijke en politieke systemen zijn belangrijk

voor een significante verbetering van accounting kwaliteit, aangezien deze zowel rechtstreeks als onrechtstreeks

invloed hierop hebben. Onwikkelinglanden hebben hiermee vaak problemen waardoor de voordelen van IFRS niet

volledig doorkomen. Uit de meeste onderzoeken blijkt wel, zeker als de andere factoren in orde zijn, dat IFRS de

accounting kwaliteit in de meeste landen doet stijgen. De belangrijkste veronderstelde voordelen hiervan zijn de

verhoogde investeringen, hoofdzakelijk uit het buitenland. Dit blijkt ook uit de literatuur, die constateren dat IFRS

zorgt voor een verhoogde flow aan buitenlandse investeringen en een verlaagde kapitaalkost. Opnieuw is de

belangrijkste voorwaarde wel goed werkende poltieke en legale instituties. Verder geeft onderzoek aan dat een

verhoogde flow van buitenlandse investeringen ontwikkeling sterk ondersteunt. Andere voordelen gelinkt aan IFRS

zijn accuratere bedrijfsbeslissingen, leveren van een bruikbaar accounting systeem voor lander zonder zo’n

systeem en aantrekkien van multinationals. Het grootste probleem van IFRS voor ontwikkelingslanden zijn de grote

implementatie- en werkingskosten. Al zijn deze kosten volgens de meeste onderzoeken niet significant t.o.v. de

mogelijke voordelen en de omzet. Andere nadelen geralteerd aan IFRS zijn gebrek aan kennis, vertalingsproblemen

en problemen bij het gebruik en berekenen van de fair value.

Verder bespreek ik de relatie tussen IFRS en ontwikkelingsorganisatie de World Bank, de specifieke IFRS standaard

voor KMO’s, en enkele cases van landen die overgeschakeld zijn naar IFRS.

Als algemene conclusie stel ik dat IFRS, in combinatie met o.a. goede wettelijke en politieke systemen, kan zorgen

voor een betere ontwikkeling in ontwikkelingslanden, mits het in acht nemen van enkele aandachtspunten.

IV

Table of contents

List of Used Abbreviations ............................................................................................................................... V

List of Tables and Figures ................................................................................................................................ VI

1 Introduction ................................................................................................................................................. 1

2 IFRS and situation at the moment ................................................................................................................. 2

3 Relationship between accounting and development ...................................................................................... 4

4 Agriculture, development and the use of IAS 41 ............................................................................................. 8

4.1 Relationship between agriculture and development ......................................................................................... 8

4.2 IAS 41 and its implications ................................................................................................................................. 10

5 Factors determining IFRS choice ...................................................................................................................15

6 Benefits IFRS for developing countries ..........................................................................................................17

6.1 Quality and relating matters ............................................................................................................................. 18

6.2 Effects of implementing IFRS on Foreign investments ..................................................................................... 26

6.3 Other benefits for developing countries ........................................................................................................... 30

7 Issues and costs IFRS for developing countries ..............................................................................................32

7.1 Costs before and after implementation ............................................................................................................ 32

7.2 Specific disadvantages for developing countries.............................................................................................. 34

8 IFRS and the World Bank ..............................................................................................................................35

9 SME standard ..............................................................................................................................................37

10 Domestic GAAP and differences with IFRS...................................................................................................40

11 Conclusion .................................................................................................................................................43

Reference List ............................................................................................................................................... VII

Appendixes ................................................................................................................................................... XV

Appendix 1 Developing countries according to the WESP report (United Nations, 2018a)..................................XV

Appendix 2 Overview differences between Nigerian GAAP and IFRS (Madawaki, 2012) .................................. XVI

V

List of Used Abbreviations

AICPA: American Institute of Certified Public Accountants

CICA: Canadian Institute of Chartered Accountants

FADN: Farm Accountancy Data Network

FDI: Foreign Direct Investments

GAAP: Generally Accepted Accounting Principles

GDP: Gross Domestic Product

HDI: Human Development Index

IAS: International Accounting Standards

IASB: International Accounting Standards Board

IASC: International Accounting Standards Committee

Ind AS: Indian Accounting Standards, converged with IFRS

IFRS: International Financial Reporting Standards

ISAR: Intergovernmental Working Group of Experts on International Standards of Accounting and

Reporting

MCA: Ministry of Corporate Affairs

MDG’s: Millennium Development Goals

MoU: Memorandum of Understanding

OCAM: Organisation Commune Africaine, Malagache et Mauricienne

OECD: Organisation for Economic Co-operation and Development

OHADA: Organisation pour l’Harmonisation en Afrique du Droit des Affaires

PCGA: Plan Comptable General Agricole

ROE: Return on Equity

SDG’s: Sustainable Development Goals

SEC: Securities and Exchange Commission

SGARA: Self-generating and Regenerating Assets

SMEs: Small and medium-sized enterprises

SWOT: Strengths, Weaknesses, Opportunities and Threats

SYSCOA: Système Comptable Ouest Africain

UN: United Nations

WESP: World Economic Situation and Prospects

VI

List of Tables and Figures

Table 1: The structure of farm income statements - some international differences .............................................. 12

Table 2: Significant factors determining IFRS choice .................................................................................................. 17

Figure 1: IFRS Required for domestic public companies .............................................................................................. 3

Figure 2: IFRS for SMEs required or permitted ............................................................................................................. 4

Figure 3: Determinants of accounting quality ............................................................................................................ 19

Figure 4: Corruption perceptions index 2017 ............................................................................................................. 23

1

1 Introduction

The purpose of this paper is to give an answer on the question: ‘Can applying IFRS rules help developing countries

in their further development?’, based on an extensive literature review.

It is not easy to determine which countries can be classified under the category of developing countries. A lot of

different definitions are used by for example the World Bank, the United Nations (UN) or the Organisation for

Economic Co-operation and Development (OECD). Different yardsticks are used like the Human Development

Index (HDI), industrial base (major economic activity in the country) and with different specific levels for

distinction. In this paper, I work with the definition of the World Economic Situation and Prospects (WESP) report

from 2018, made by the United Nations (United Nations, 2018a). This is based on basic economic country

conditions, with the developing countries having the worst conditions followed by countries in transition and

finally the developed countries. It could be argued to place some countries in multiple categories, but the used

definition is mutually exclusive, so every country is placed in only one category. To give a small and gross summary

of the developing countries in the definition, there are all African countries, most Asian countries (excluding the

likes of Russia, Kyrgyzstan, Kazakhstan, Azerbaijan, Armenia, Tajikistan and Turkmenistan) and all countries of Latin

America and the Caribbean. An overview of all developing countries can be found in Appendix 1. It is clear that the

majority of countries worldwide can still be classified under developing countries according to the WESP definition

(United Nations, 2018a).

Due to the growing globalization over the years, demand for a unified accounting system rose dramatically. The

International Accounting Standard Board (IASB) recognized this demand and developed the International Financial

Reporting Standards (IFRS, former IAS) (Picker et al., 2016). Today these standards are widespread and used by the

majority of countries worldwide. With this overwhelming success, the question can be asked to what extent the

standards can help developing countries in their economic growth. (IFRS, 2018a)

Good accounting quality and a uniform accounting system are basic requirements for development. Absence of

good accounting rules, adapted to the specific situation of the developing country will delay or obstruct the

process of development (ACCA, 2012; Boyns & Edwards, 1991; Hopper, Lassau, & Soobaroyen, 2017). The

relationship between accounting and development is broadly accepted and is expressed in the Sustainable

Development Goals (SDG’s) of the United Nations and in numerous agenda items from development organizations

(Gordon, Loeb, & Zhu, 2012; United Nations, 2018b). The most important question to be posed is if IFRS can help

to enforce this relationship.

Prior research mainly concludes that IFRS can have positive influences on accounting performance in developing

countries (e.g., Ahmed, Neel, & Wang, 2013; Ball, 2006) but little research has been done on the relation with

development. The paper wants to solve this gap by investigating the potential benefits and issues with IFRS and

their relationship with development, based on research of both development and IFRS.

2

Not only the use of IFRS as a whole needs to be investigated, but also separate important matters like IAS 41 about

agriculture (essential in most developing countries) and the specific SME standard.

The remainder of the paper is organized as follows. Section 2 describes the history of IFRS and the compliance by

country. Section 3 examines the relationship between accounting and development. In section 4, the relationship

between development and agriculture is discussed and the effectiveness of the related IAS 41. Section 5 delivers

the factors why countries are choosing IFRS. In section 6 the benefits of IFRS for developing countries are studied

extensively while section 7 gives an insight about the related issues and costs. Furthermore, the relationship IASB-

World Bank (section 8) and IFRS for SMEs (section 9) are discussed. In section 10, key differences and specific cases

of GAAP vs. IFRS are examined. Finally, section 11 provides the conclusion.

2 IFRS and situation at the moment

Nowadays economic globalization is getting more and more important. Many companies performing in different

regions had or still have to use different accounting standards for their departments located across countries. With

the introduction of IFRS (or the former IAS), the International Accounting Standards Board (IASB) seeks to

harmonize accounting standards in countries worldwide and increase the comparability, credibility and

comprehensibility for the most important stakeholders like investors and governments (Aryanto, 2011).

The IASB cannot obligate governments to use these standards, but the more they are used, the easier it will be to

compare companies worldwide and this will enhance investment decisions.

IASB explains in their own IFRS conceptual framework that their main intention is to create a system

understandable and usable for a broad range of users:

‘The objective of general purpose financial reporting is to provide financial information about the reporting entity

that is useful to existing and potential investors, lenders and other creditors in making decisions about providing

resources to the entity’ (IFRS, 2010, OB2).

In that same conceptual framework, IASB determines some qualitative characteristics of useful financial

information that can be included in the general purpose financial reporting. They are talking about two

fundamental principles: relevance and faithful representation, and four enhancing characteristics: comparability,

verifiability, timeliness and understandability. I can also add a cost-benefit constraint, where it is necessary that

the benefits of presenting the financial information by IFRS (like higher investments and quality) exceed the costs

of using it (like collecting and processing information, verifying information and distributing information) (IFRS,

2010; Picker et al., 2016).

The first foundation for IFRS was laid in 1973 by creating the International Accounting Standards Committee (IASC).

It was established in London by 16 national professional accountancy bodies spread over nine different countries

(Canada, UK, US, Australia, France, Germany, Japan, the Netherlands and Mexico). Its purpose was to design

International Accounting standards (IAS) for cross-border listings. In 1990, IASC completed their initial aim of 31

published standards. Although expanding and being backed by more and more respected accounting bodies, the

IASC had a lot of shortcomings (Picker et al., 2016).

3

There were weak relationships with the standard setters in most countries, despite working on this for several

years, the convergence between the IASC standards and other standards used in major countries wasn’t sufficient,

there was no full-time board and they had too few financial resources and technical support.

That is why in 2000, it was decided to replace the IASC by the full-time, yet smaller, IASB. The IAS standards were

taken over with some minor adaptations. Standards created or modified after that were given the name of IFRS.

The IASB is better equipped and has better relationships with national standard setters by including them in the

board (IFRS, 2018g; Picker et al., 2016).

In 2005, all EU members started using IFRS to replace their separate and conflicting national accounting standards.

This was the starting shot for many more countries to follow the EU and introduce IFRS in their national accounting

politics. Other countries like Australia and New Zealand followed shortly after that. Also, many developing

countries are trying to adapt to IFRS, but this adoption could cause a lot of significant problems as a result of local

cultures and specific practicalities in economic development (Fino, s.d.).

Now 158 countries either require or allow the use of IFRS, of which 144 obligate the use for all listed companies

choosing to prepare general purpose financial statements. Most countries keep an own Generally Accepted

Accounting Principles (GAAP). Often this GAAP is similar to IFRS with some changes in definitions, omissions of

certain standards, time lags in introducing new standards… (Deloitte, 2012; IFRS, 2018a)

To look at the progress of the IASB goal toward global adaptation, I look at the next two figures. They show,

respectively, the countries where IFRS is required for domestic public companies and the countries where IFRS is

also required or permitted for all Small and Medium Sized Enterprises (SMEs). Countries in blue are those who

adopted IFRS. The data are representative for the situation in May 2018 (IFRS, 2018a).

Figure 1: IFRS Required for domestic public companies (IFRS, 2018a)

4

Figure 2: IFRS for SMEs required or permitted (IFRS, 2018a)

Remarkable conclusions from these figures can be drawn. Looking at Figure 1, while the majority of countries (144

of the 166 investigated jurisdictions or 87%) require IFRS as the standard for domestic public companies, it is

mainly developing countries that do not use the standards yet. However, as of today, the majority of developing

countries is already requiring or at least permitting IFRS. Other big exceptions like China and the USA have their

own well worked-out standards, but these are converging increasingly towards IFRS (IFRS, 2018a).

Figure 2 shows that fewer countries require or allow IFRS as a standard for their SMEs to use (86 out of 166

investigated jurisdictions or 52%). Many countries keep their own system, which is usually more adapted to the

local needs of these smaller companies (IFRS,2018a). A lot of developing countries, especially in Latin-America, are

permitting the IFRS system for SMEs, in most cases due to the lack of a well-developed domestic system. In doing

so, they will have to be careful that the system is sufficiently adapted to the local situation. The solution for this

could be to start from IFRS and modify to shape for the domestic circumstances. In section 9 this specific standard

for SMEs is further discussed in detail. The actual adaptation of IFRS is a rather recent phenomenon. This causes

disadvantages for researchers lacking long-term data to evaluate if the consequences continue to maintain

(Samujh & Devi, 2015).

3 Relationship between accounting and development

In this section I will discuss the main reasons why accounting in general is an important factor for development.

Later on in this paper, for example by discussing the advantages of IFRS, other factors for development related to

accounting are mentioned like legal systems, political systems and financial markets.

Economic development and the advantages that follow from this, like reducing poverty and income inequalities,

are the main goals of most developing countries (IFRS, 2018d). In this process, accounting is often neglected

because of the focus on development itself.

5

Governments, most aid organizations and other influencers sometimes ignore the importance of the accounting

field for developing countries. While accounting itself will not solve the problem of poverty, neglecting it is proven

to be an obstruction in the process of development (Hopper et al., 2017).

Starting from the late 1960s and 1970s the effects of accounting on development were explained in some

research, but it was only around 1997 with Wallace (1997) that it specifically became a topic of interest in a lot of

academic research. Previous researchers focused on accounting in developed regions with neglecting the situation

in for example Africa. Topics like globalization and development were rarely discussed. Wallace (1997) explains

that because of various reasons the existing research was not applicable for African and other developing

countries. After this paper a lot of research started focusing on accounting and economic development in

developing regions. These papers all confirmed that accounting has an important role in economic growth (ACCA,

2012; Boyns & Edwards, 1991; Hopper et al., 2017).

In Hopper et al. (2017) it is explained that the simple takeover of accounting rules from richer countries, which is

happening in most developing countries, won’t solve the issue of bad accounting. Cultural differences, local

circumstances and needs, governmental problems, implementation difficulties and a financial focus over

development goals are the major causes of this issue. One thing they need to focus on is the adaptation to an

agricultural oriented economy, which is important for most developing countries, but not anymore for most

western countries. More on that is described in section 4.

From a historic point of view, the rate of a country’s economic growth has a certain correlation with the rate of

accounting development of that specific country. Fino (s.d.) gives us many reasons why this relationship exists.

Good accounting is necessary so that the (limited) resources are distributed to the right and most productive

companies. Government and investors who can provide these resources need reliable and useful information

about the financial statements for efficient resource allocation.

Furthermore, accurate accounting information is also important for a firm's planning, control system and basically

any economic related decision. Another advantage of good accounting in developing countries is that it can assist

in the solution for wide range of problems blocking economic growth they are usually coping with. Unemployment,

bad education system, globalization and free trade issues are some of these internal and external problems they

need to cope with.

Fino (s.d.) concludes that a good accounting system is a useful and necessary tool for economic development, but

it is important that each country takes into account its own (environmental) conditions for the development of an

accounting system. As the rate of economic development expand, accounting becomes more important. For

companies in fast developing countries, good accounting information is important to contend in highly competitive

markets.

6

Salisteanu and Oros (2015) argue that accounting has a direct influence on economic development and

furthermore, it also supports national economic planning with information creation. When good quality

accounting information is delivered, development is supported by promoting financial stability, attracting external

funding (this is discussed in section 6.1), and supporting better investment decisions. This proves that accounting

plays an important role in many areas of the economy and economic growth, but also that it depends on other

related areas. To really get an impact on development, the accounting quality is the basic requirement. However,

this quality is affected by all kind of factors like legal and political institutions, financial markets… More on that is

explained further on in section 6.1 (Soderstrom & Sun, 2008).

Accountancy is an important determinant for strong and healthy economic markets and enterprises. It influences

the economic development of countries and should be taken into consideration for developing countries (Perera,

1989). This was also the mindset of the United Nations when creating the Sustainable Development Goals (SDG’s)

towards 2030. These goals were launched in 2015 and consist of 17 major goals with 169 sub-targets. The aim is to

end poverty, protect the planet and ensure prosperity for all, with economic development as the most important

factor for reaching these goals. According to a survey from PricewaterhouseCoopers in 2015 the majority of

companies is planning to include the SDG’s in their business operations because including them can have a

significant positive impact on the results of the enterprise because of better communication towards stakeholders,

quality management and transparency of the company (United Nations, 2018b). This adaptation from enterprises

was an important target by the goal setters because in order to reach most goals the private businesses play a

major role. That is why, unlike the predecessors like the Millennium Development Goals (MDG’s), these goals were

set in cooperation with public and private sector organizations, governments, society… and not only by the world

leaders themselves. The importance of accounting in achieving the goals was officially acknowledged in the thirty-

second session of the ISAR (Intergovernmental Working Group of Experts on International Standards of Accounting

and Reporting). It is important that accountants include both quantitative and qualitative information about

development and the progress of SDG’s in their reports (Allen, 2015; Bebbington & Unerman, 2018; United

Nations, 2018b).

The International federation of accountants (IFAC) are stating that the accounting profession has an important

impact on at least eight of the 17 SDG’s. In 2016 they published a policy document about how and why the

accounting profession could have an impact on the SDG’s. For the most important SDG’s they are talking about #4

quality education, #5 gender equality, #8 decent work and economic growth, #industry, innovation and

infrastructure, #12 Responsible consumption and production, #13 Climate action, #16 Peace, justice, and strong

institution and finally #17 Partnership for the goals. The achievement of these goals can be supported by

accounting and the profession can also transform itself to tackle the new development challenges. Section 6 of the

#12 goal specifically states that it is an objective to convince businesses to integrate sustainability information in

their reporting cycles. With at least 3 million accountants being member of cooperating organizations for the goal

setting, can conclude that accounting has an important role in the whole spectrum of the SDG’s (Makarenko &

Plastun, 2017; United Nations, 2018b).

7

Perera (1989) explains that accounting is important so that the used macroeconomic policy of a country is in line

with the broad national economic goals. A comprehensive accounting system with well-developed and well-

adapted standards can be used as a ‘main database system for economic decision-making’. Some developing

countries did not even have a professional accounting body to determine some ground accounting rules in their

country, which caused major troubles for governments on the way to economic growth.

Further on in the paper, Perera (1989) sums up a wide range of reasons of why a uniform accounting system is

necessary in the situation of developing countries. According to the author, this can help to advance economic

growth. First, the need is bigger for countries with greater governmental involvement in economic decisions,

which is usually the case for developing countries. Government and supporting authorities usually interfere more

with the economic situation by determining a development plan and trying to achieve the described targets. The

central planners need good and reliable information about the economic situation for effective planning. The most

efficient way to gather this information is if the enterprises are using a uniform accounting system they can trust.

Second, with scarce resources like most developing countries have, self-regulating market mechanisms won’t be

efficient enough for the resource distribution and governments have to interfere. Accounting information is

needed for comparison between different companies to find out which ones need government interventions and

support. Because of this, the most productive companies can be supported and ensure further economic growth.

The third reason is the lack of accounting knowledge and education in many developing countries. Governments

need to take the matters into their own hands because they cannot count on good judgments of the local

accountants. Fourth, trained management, which is rather scarce in developing countries, is a major condition for

development in most countries. Important here is that trained management can only work their best if they can

work with a well-developed accounting system. However, also less-trained management may have better chances

to succeed in a situation with uniform accounting rules. Fifth and final relevant reason from Perera’s paper (1989)

is the cultural and social difference between countries which can affect economic decisions. Developing countries

usually are more group oriented than the rather individualistic oriented industrialized countries. Uniformity like an

accounting framework is more desired in countries with preference for the interest of the society rather than the

individual and countries with a larger power distance (higher correlation with collectivistic countries because

hierarchical relationships are more accepted in these cultures). All these former mentioned reasons plead for a

uniform accounting system throughout the country or across countries in developing countries to support further

development. IFRS might be an option here (Perera,1989).

Thus, the general conclusion is accounting has an impact on economic development, mainly by blocking the

process when there is lack in accounting quality (e.g., Hopper et al., 2017). This is proven by research and also by

other factors, like the incorporation of accounting importance in the SDGs by the United Nations. In the next

sections, the relation between IFRS and development is discussed.

8

4 Agriculture, development and the use of IAS 41

Arguably the most important standard for most developing countries is IAS 41 about accounting for agricultural

activity. The biggest difference with high-income countries is that in most cases they can be classified as

agricultural oriented economies, meaning their main economic industry is agriculture in all its forms (Hopper et al.,

2017). Accounting on agriculture has always been a weakness in many standard setting systems and little research

is done about this subject in relation to the importance of it. Some standards already existed, but the IASB wanted

a new separate standard to harmonize bookkeeping in the agricultural industry (Elad, 2004; IFRS, 2018b).

First, I am going to describe the relationship between agriculture and development to investigate if the agricultural

industry could help developing countries in their economic growth and therefore if it is useful to invest in

accounting on agriculture in these regions.

Second, I am going to describe the IAS 41 standard and resume the most important advantages and disadvantages

of this standard, mainly for developing countries. It is important to see if this standard can be adapted to the local

situations and if it can benefit the agriculture-development relationship described in 4.1 (Deloitte, 2017).

4.1 Relationship between agriculture and development

Awokuse & Xie (2015) describe the causal relationship between agriculture and economic growth for several

developing countries. Whether or not this relationship exists has been a debate for several years and the answer

probably varies depending on the country. However, most research (e.g., Awokuse & Xie, 2015; Gollin, Parente, &

Rogerson, 2002; Johnston & Mellor, 1961) finds a positive relationship. It is an important question because it can

direct governments and policy makers to choose a certain position for the distribution of focus and investments in

this industry. It was and still is often agreed that agricultural development was the only path to real economic

growth and industrialization. Most textbooks about development suggest that the increase in agricultural

productivity is a first step for development and economic growth. This triggers the shift to a more industrialized

economy.

Gollin et al. (2002) created a model where they came to the conclusion that low agricultural development has a

significant impact on economic growth and can delay future industrialization from a country. By investigating 62

countries between 1960 and 1990, they state that although the productivity in non-agricultural industries will

decide the country’s relative income, countries first have to invest in agricultural productivity to trigger

industrialization in the future. The most important reasoning behind this is that when agricultural productivity

progresses, labor force shifts to other sectors in the economy. Furthermore, it creates means and resources in

these countries to shift to a more industrialized economy.

To find the reasons for the relation between agriculture and the development of other -more industrialized-

sectors, I look at two important papers about this subject (Johnston & Mellor, 1961; Timmer, 1995). Note here is

that it is hard to find reasons applicable for all developing countries because of a wide range of different situations,

density of the population, degrees of development and so on, but these papers tried to find relationships

applicable for most developing countries. Johnston and Mellor (1961) describe five reasons why this relationship

between economic growth and agricultural productivity exists.

9

They second the ‘agriculture first, industrialization next’ (e.g., Gollin et., 2002) hypothesis, but with an important

footnote. Countries that can generate a considerable part of their capital requirements with the export of mineral

products or that can get major foreign loans and grants, could reach the industrialization phase without heavy

counting on agriculture. The five identified reasons why agricultural productivity is important for further

development, in this paper from Johnston and Mellor (1961), are (1) providing increased food supplies by reason of

higher population growth in underdeveloped countries and higher income elasticity for food (the demand for food

will grow faster with GDP per capita growth than in more developed countries). A failure to enhance the food

supplies could partially be tackled by import from other countries and the price elasticity is not that immense, but

it would still cause serious penalties if productivity would fail to meet up with the demand. Side note is that fast

productivity gains can also provoke the opposite problem where there is excess supply.

(2) Enlarged agricultural exports; productivity gains will make it possible to export more and maybe different sort

of crops abroad with mostly rather small investments. This export is one of the easiest and best possible practices

to increase the profits for low-income countries. In the long run, it will be important to diversify the product range

of crops to reduce risks (Johnston & Mellor, 1961).

(3) The Transfer of manpower from agriculture to non-agricultural sectors. As already mentioned in this section,

productivity in the farming sector could solve the problem of growing labor demand in growing businesses. There

is again a pitfall, if the demand for profitable crops increases too fast, the transfer to the other sectors could be

rather low (Johnston & Mellor, 1961).

(4) Agriculture's contributions to capital formation. In the new, industrialized sectors capital is one of the most

important resources. To make big investments and employ a lot of -higher waged- employees there is a big capital

requirement. Also, for governments it is important to get a lot of capital in the early development of the new

sectors for creating and enlarging companies, investments in transport, utilities and other supports like education.

In developing countries, the largest share of capital needs to come from the agricultural sector and that is why a

productivity gain is necessary. Like explained later on in this paper, governments and other leading entities could

slow down this process due to problems like corruption and lack of control (Johnston & Mellor, 1961).

(5) The final reason given by Johnston and Mellor (1961) is Increased rural net cash income as a stimulus to

industrialization. Together with the capital growth, it is necessary that there are chances for beneficial

investments. Increment of the purchasing power in the countryside can cause a proper improvement for

development of industrialized industries.

Timmer (1995) adds rather indirect ways how agriculture can support economic development. Again, he is one of

the big pool of believers that agricultural and non-agricultural economies are strongly linked and that agriculture is

the stepping stone to development. Timmer (1995) demonstrates that agriculture can have an effect through non-

market linkages, and governments need to intervene when these linkages are not working well by facilitating

them. These linkages vouch for better labor and capital resources and their productivity by a more efficient

allocation. They are originated by a lot of possible factors like food availability, stability of the price of food and the

cutback of poverty.

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Although the majority of researchers (e.g., Awokuse & Xie, 2015; Gollin et al., 2002; Timmer, 1995) stands behind

the belief that agriculture is the basic step for economic growth, this hypothesis is only rejected by a very small

pool of economic researchers (e.g., Matsuyama, 1992). The main reason why they reject this hypothesis comes

from basic economic data, showing that most countries with low GDP growth still have a significant share of their

economic activities in agriculture and seem to remain stuck in poverty without a lot of prospects for fast

development. This negative position towards agriculture is also followed by a lot of governments in developing

countries establishing some kind of anti-agricultural policy in their development strategies. Examples are heavy

taxes and unfavorable economic conditions for agriculture and strong support for the manufacturing sector in

which they believe more (Matsuyama, 1992).

Matsuyama (1992) used a methodological approach to counter the strong linkage between agricultural

productivity and development. He brings up evidence for a negative relationship between the two because of

strong competition for resources between agriculture and the manufacturing sector. He believes that, when there

is low agricultural productivity, the labor force will be reduced, which will cause higher supply and lower labor

prices, which is necessary for the manufacturing. However, the author says that there can be a positive

relationship, but only when there is no spill-over of learning by doing between different economies and the

knowledge capital is specific to a particular region. In all other cases the model from Matsuyama (1992) shows a

negative relationship between agricultural productivity and development.

Rattso and Torvik (2003) base their research on the model of Matsuyama (1992) and therefore presuppose in

advance that sub-Saharan Africa made the right choice by partially neglecting agriculture and immediately focus

on industrialization, based on the used models. However, they cannot explain why these countries still failed to

significantly increase industrialization. They found that neglecting agriculture and promoting industrialization

damaged the economic growth in sub-Saharan Africa.

To conclude this debate, most development theories show a significant positive relationship between agriculture

and development. The abovementioned paper of Awokuse and Xie (2015) is one of the most recent and broadly

accepted studies using ‘inductive causation’ to investigate the causal relation in several developing countries. Their

conclusion shows mixed results that vary country by country. However, in most countries he found a positive

relationship and his suggestion is to heavily invest and stimulate agriculture in these countries. Following this

conclusion and most ‘believers’ in a positive relationship (e.g., Gollin et al., 2002; Johnston & Mellor,1961),

agricultural productivity should be taken into account as one of the key factors of development.

4.2 IAS 41 and its implications

Having an accounting standard that is adapted to the agricultural activities of developing countries is essential.

That’s why IAS 41 should be well worked out so IFRS can contribute to development. Most developing countries

are currently using IFRS as foundation for their accounting system, resulting in using IAS 41 in most cases (they

could also opt to use most IFRS standards but not choose this particular one) (IFRS, 2018a).

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The IASB defines agricultural activity as ‘the management of the biological transformation of biological assets

(living animals or plants) and harvest of biological assets for sale or for conversion into agricultural produce or into

additional biological assets’ (IFRS, 2018b). In practice this means that the scope of IAS 41 is for (1) biological assets,

(2) agricultural production at the point of harvesting (process after the harvest is not included in the standard) and

(3) government subsidies related to these farming activities. Beyond the scope of this standard are, among others,

land related to agricultural activities, intangible assets connected with these activities and unclaimed, unmanaged

agriculture like oceans and mining activities.

A special case are the bearer plants (plants that can grow biological assets, e.g. fruit trees) and government grants

related to them. Both are excluded from IAS 41 (IFRS, 2018b).

In June 2017, after already making an adjustment in June 2014, an amendment was emitted by the IASB, stating

that the bearer plants (but not the biological assets growing on them), have to be accounted for under the

standard of IAS 16 Property, Plant and Equipment (IFRS, 2018b).

In 1994, the IASC Board decided they needed a separate standard for agriculture because it is very different from

most other sectors. They developed the standard in cooperation with the Steering Committee, who published a

Draft Statement of Principles (DSOP) in 1996 that was reviewed and revised before sending it to the Board. The

approved draft was issued in July 1999 by the Board and stakeholders like international organizations and

individual countries could comment on it (62 command letters in total). Additionally, a questionnaire was sent to

many agricultural enterprises. It was really important for the IASC to get the view of the stakeholders about this

standard, so they incorporated these comments and questionnaires. Ultimately, the standard was issued in

December 2000, but first applied in January 2003. (IFRS, 2015, 2018b).

There are two major differences between IAS 41 and most other standards about agricultural accounting. The first

one is the use of a fair value model instead of the historical cost model. Biological assets should be recognized at

fair value less costs to sell. Two exceptions on using fair value are at the very early stage of an asset’s life and when

there is no reliable fair value measurement at recognition (PwC, 2015). Fair value is defined in IFRS 13 about Fair

Value Measurement as ‘The price that would be received to sell an asset or paid to transfer a liability in an orderly

transaction between market participants at the measurement date’ (IFRS, 2018c, Appendix A). The most important

characteristic I get from this definition is that it is a market-based instead of an entity-specific measurement, but

there is not always a comparable market or market transaction for the asset/liability which can cause difficulties

for an accurate measurement. Furthermore, the definition stresses orderly transactions (not forced or distressed

like what happens with liquidations) and it should be measured at exit price (‘the price that would be received to

sell an asset or paid to transfer a liability’). For an in-depth description of the fair value measurement, I like to refer

the reader to IFRS 13 on the website of IFRS (IFRS, 2018c).

The second major discrepancy is that when there is a value change of the crops, it should be immediately

recognized as income. Meaning that unrealized gains/losses while growing the crops are booked as income. This is

referred to as the ‘accretion approach’ (PwC, 2015). As mentioned in Aryanto (2011), there are two big arguments

behind this choice. First, biological assets can be sold at any time in their lifespan, thus at various market prices.

Second, the further the biological assets are in their lifespan, the more valuable they become.

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This explains why revenues are created during the full growth process of the crops and therefore it could be logical

to already take this growth process into income. An important note mentioned in IFRS is that the realization of the

not yet realized asset should be certain and only be a matter of period (Aryanto, 2011).

As explained below, these two changes caused disagreement in the accounting industry (Elad, 2004).

The unofficial predecessor of IAS 41 was a standard from the French PCG regulations in ‘Plan Comptable General

Agricole’ (PCGA) from 1986. It was only mandatory for French agricultural enterprises but was used as a guideline

for foreign enterprises before the new IAS rule. This regulation has also been used as foundation for the

agricultural guidelines in the ‘harmonized accounting systems’ in Francophone Africa called SYSCOA (Système

Comptable Ouest Africain) PCG for Francophone West Africa, and OHADA (l’Organisation pour l’Harmonisation en

Afrique du Droit des Affaires) PCG for Francophone Central Africa. These were the successors of the now

disbanded Organisation Commune Africaine, Malgache et Mauricienne (OCAM) PCG (Elad, 2004).

Apart from the PCG, a lot of other big countries or regions created their accounting standard on agriculture.

The Farm Accountancy Data Network (FADN, °1965) established by the European Commission, the Canadian

Institute of Chartered Accountants (CICA, °1986) and the American Institute of Certified Public Accountants (AICPA,

°1996) are some of the most important one and are all very similar to the French regulations (Elad, 2004).

Above-mentioned standards all differ majorly from the new IAS 41 rule, with historic cost for valuation, stocked

production shown as costs… The Australian standard AASB 1037 (°1998) on Self-generating and Regenerating

Assets (SGARA) was the only widely recognized standard sharing a lot of similarities with IAS 41 with the use of Net

Market Value (similar to fair value), unrealized gains/losses in income, etc. (Amalia, 2006; Elad, 2004). Table 1

shows a short summary of the biggest differences between the abovementioned standards.

Table 1: The structure of farm income statements - some international differences (Elad, 2004)

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The key question for this paper should be whether or not IAS 41 is adapted to the local situation of developing

countries and if it could help increasing the agricultural productivity in these countries.

Elad (2004) describes that by the issue of the IAS 41 rule, strong opposition from several important accounting

institutes in Canada, US, UK and Australia was formed. The new standard was on many points completely different

from the former recognized standards like mentioned above and this created some major debate topics. Especially

replacing the historic cost principle, which was the norm for years, by the fair value approach caused some major

problems for the adoption worldwide. Other main points of critique were the shortcoming to adapt for the

situation in less developed countries and the focus to back investors in more developed countries (Elad, 2004).

One positive point for the IAS 41 and its fair value accounting is that when an active market for the biological asset

exists and is comparable, the valuation could be easier and more relevant. This can trigger governments in

developing countries to impose relevant taxes based on the fair value valuation on multinational companies in

order to protect their own natural resources and supporting their own local farmers.

However, a lot of reasons reveal the weak spots of IAS 41 for their goal of International compliance and economic

growth in developing regions (Elad, 2004).

First of all, the calculations of fair value are not always that easy and straightforward. There is not always a

comparable market and some subjective factors like the choice of similar assets can disturb the comparability

principle. Certainly, in developing countries it is hard to find the right market and artificial increase in value is

common. However, in the development of the standards, questionnaires were sent to agricultural companies in

order to know their opinion about the fair value proposition in the draft. The majority of the 20 questionnaires

responded positively to this so I should be careful with a conclusion about the utility of fair value calculation in the

standard (IFRS, 2015).

The second reason is the disruptive changes that this standard brings to the former French PCG model and its

African variants. It is not possible to harmonize both models which means changing to IAS 41 asks for radical

modifications and investments for most developing countries where agriculture is the key entrepreneurial activity.

(Elad, 2004)

Third weakness from Elad (2004) is that the obligation of yearly revaluation, to get the ongoing fair value, could be

a pricey and difficult manner which can particularly affect the results of companies in developing countries.

However, there may be some discussion about which method is more difficult. The majority of parties and entities,

like the European Commission and most British accounting entities, back the assumption that the old and

widespread cost accounting system is much more straightforward and easier. Their argument against IAS 41 is that

it is based on the ‘accretion approach’ where revenue is already recognized before the completion of the crop and

not all at the end of production or at sale. This provokes too many uncertainties about the price and effective

marketability of the crops.

On the other hand, Argilés and Slof (2001) are firm believers that IAS 41 will make Agricultural accounting much

easier. Their research starts from the European situation with the FADN setting the guidelines which were, just like

in most other regions and bodies, very different from the IAS 41 standard. Argilés and Slof (2001) investigated use

of the FADN guidelines and proved that these had a fairly common use before the IAS 41. The authors are

convinced that IAS 41 is easy to implement, and that simplicity is one of the key advantages of the standard.

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With some modifications, the FADN guidelines could be reformed in line with IAS 41 but also vice versa, IAS 41

could implement some things from the FADN. Some minor ‘points of critique’ on IAS 41 they have are (1) there is

need for an explicit distinction between the disclosure of farming and off-farming income, (2) valuing ending

inventory with the fair value method when the harvest is done might be too difficult and expensive and (3) issues

about remuneration of family work and such are not elaborated (Argilés & Slof, 2001).

Getting back to the paper from Elad (2004), the fourth point of criticism he expresses is the big difference between

IAS 41 and the EU fourth directive. The treatment of gains and losses is completely opposite according to a

publication of the European commission. This counters the abovementioned findings from Argilés and Slof (2001)

claiming that there is no conflict between both approaches with both using accrual accounting. These differences

are all mainly recognized between IAS 41 and most other standards used or being used in developing countries.

The fifth point of criticism from Elad (2004) concerns the barriers for implementation of IAS 41 that were already

perceived with the Australian AASB 1037 standard and are very similar for IAS 41.

Problems go from being too academic instead of practical with the need of more field studies, to problems with

measurement methods that were used interchangeably instead of only using the market value approach. Dowling

& Godfrey (2000, p50) summarize the problem of implementation with ‘it is possible that the limited use of net

market value measurement by firms reflects the absence of information systems capable of detecting, tracking,

and recording reliable SGARA net market values’, with SGARA meaning self-generating and regenerating assets

where crops are a part of. These critiques caused the Australian standards setters to postpone the commissioning

with one year.

Finally, the last negative point elaborated by Elad (2004) is very important for a lot of developing countries. For

forest industry in tropical weather countries, the implementation could be even harder due to the ownerships of

the forests that are usually determined and divided to exploitation countries with ownership contracts. The root of

the problem is that these contracts need to be seen as a financial lease contracts and consequently they are

covered by IAS 17 about leases. However, to measure and elaborate biological assets in their financial statements

they need to use IAS 41. According to the latter standard, fair value changes should be presented as income which

could lead to these companies reporting illusionary or phantom profits from massive unrealized holding gains for

assets they only have in concession, but do not really possess.

Since this influential study of Elad (2004), other academics also dealt with the evaluation of IAS 41 with mostly

similar conclusions. In a more recent study Aryanto (2011), based on other empirical studies over the seven years

the standard had been used back then, concludes that the expected benefits by the IASB for using IAS 41 have not

been reached. The main objectives for this standard of comparability and basis for agricultural accounting in

developing countries are not achieved. First, the comparability objective is not exactly met because net value can

be measured with different methods (NPV, external valuation…) while the historical cost model had only one clear

equal method. Furthermore, most entities were unable to meet all disclosure requirements compiled by IAS 41.

Second disadvantage spotted is that the cost benefit constraint, as in stated in the IFRS conceptual framework, is

not met in most situations. The high costs can be a major burden for enterprises in developing countries. Third, the

fair value method caused an increase in volatility of the earnings. If unrealized earnings are taken into account for

profit and loss calculations, this will be mostly taken into account for dividend provisions.

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Fourth, the role of the auditor in controlling the application of the standard is different over the different countries

using IAS 41. And finally, the data are inaccurate in a lot of cases, a problem mainly occurring in countries with

tropical weather where there are big differences between the fair value determined by the authorities and the real

fair value of coffee, tea and bananas. This is a clear example of a recurring problem in standards: an

overgeneralization of treatment for certain biological assets used for all biological assets (Aryanto, 2011).

The papers from Elad (2004), Aryanto (2011) and a lot of other academic work argues that there are too many

problems to facilitate developing countries in their agricultural accounting. The IASB is making adjustments, like

the case from bearer plants, but this is certainly not enough to use this standard as a firm base for developing

countries for their agricultural accounting standards. The main pitfalls can be summarized as follows:

● No straightforward fair value calculations, specifically in developing countries

● No harmonization possible with most other standards

● Major differences between IAS 41 and other agricultural accounting standards, making it costly to change

● Big barriers for implementation (too theoretical, multiple valuation methods…)

● Too costly and difficult to use

To conclude this section, I can say that IAS 41 has too many difficulties at this point to facilitate developing

countries on the level of agriculture (Aryanto, 2011; Elad, 2004).

As discussed in section 4.1, in many cases the agricultural industry could be a stepping stone to development

(Awokuse & Xie, 2015; Gollin et al., 2002; Timmer, 1995). But with the issues according IAS 41 today, retaining the

specific agriculture standard might be a better idea for many developing countries in their objective of economic

growth. However, this does not mean that all IFRS rules are not helpful for development. The discussion of the

IFRS system as a whole for developing countries will be held in the next sections.

5 Factors determining IFRS choice

It is important to gain an insight in which factors are persuading developing countries to use IFRS. It could help

policy makers with their decision whether or not to use IFRS and gives information about the working points to the

IASB in their objective to reach worldwide implementation.

Zeghal and Mhedhbi (2006) are the first to investigate these main factors in the context of developing countries.

The investigated hypotheses are developed based on prior research and were tested on the case of 32 developing

countries that used IFRS and 32 that did not back in 2003.

Zehri and Chouaibi (2013) did a similar research based on Zeghal and Mhedhbi (2006), with as main differences the

sample done five years later (2008) and the addition of new investigated factors like the legal system and political

environment. Below I will discuss the variables and conclusions based on both papers, which are fairly conflicting.

Their conclusions are important and could be used by policy-makers for the decision of implementation.

First of all, both papers found that education level has a significant positive influence on the adaptation. This can

be explained by the requirement of high knowledge and skills to understand and implement the IFRS rules. In prior

research it has been found that there is a positive relationship between education level and skills of professional

accountants. The higher skill requirement therefore triggers a higher education quality need.

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A second investigated factor is the existence of a financial market. For this one, only the first paper from Zeghal

and Mhedhbi (2006) finds a significant positive relationship. This factor, as described further on this paper in

section 6.1, is a main factor for development and for the advantages of IFRS to work. Furthermore, financial

statements of high quality, which could potentially be provided by IFRS, are necessary for financial markets to

work because investors constantly need fresh, reliable and comparable information to make good decisions and

help for an efficient flow of resources to the right companies.

Therefore, you could argue an influence in two directions. When countries have a capital market, governments are

expected to give more attention to high-quality accounting systems to provide this necessary reliable accounting

information for investors. However, in Zehri and Chouaibi (2013) this factor is highly insignificant (but positive).

The third investigated factor in both papers is the importance of culture in the decision of accounting system

choice. Nobes (1998), as mentioned in Zeghal and Mhedhbi (2006), concluded that countries usually adopt a

similar accounting system used by countries with a culture alike to theirs. Other research confirms this assumption

and therefore came to the conclusion that developing countries with a lot of Anglo-Saxon influences usually have

better developed accounting systems and have less barriers for IFRS adoption. This because of the fact that the

IASB is mainly influenced by Anglo-Saxon countries which makes these systems more alike. The hypothesis that

these Anglo-American developing countries are more likely to adopt IFRS is again only significant in Zeghal and

Mhedhbi (2006).

Fourth, I look at the rate of economic growth. Here, only Zehri and Chouaibi (2013) note a significant positive

relation. This is backed by the IASB structure, which is mainly composed and shaped by developed countries and

therefore predominantly deal with their problems. Adhikari and Tondkar (1992) concluded that the level of

economic development of a country has a positive association with the development of an accurate accounting

system (like IFRS). However, they found an insignificant relationship and thereby support the insignificance of the

positive relationship concluded by Zeghal and Mhedhbi (2006) for this factor.

The fifth and last factor discussed by both papers is the degree of external economic openness, which is mainly

reflected in an increased number of foreign transactions. Cooke and Wallace (1990) were the first authors to

include the significance of external factors for the accounting system choice in their study with distinction between

developing and developed countries. One of their conclusions was that external pressures like new technological

opportunities, increased competition and international laws rise when the level of openness of that country

increases. These pressures could be partly scaled down by the use of IFRS. However, although clearly having a

positive association, examination of both researched papers did not conclude a significant relationship.

Finally, there are two variables only investigated by Zehri and Chouaibi (2013). First, they tested if a common law

legal system could stimulate choosing IFRS. This common law system is used in Anglo-Saxon countries while

continental Europe is mainly using the written code law system. The common law system has highly influenced

IASB decisions and that is why countries with this system could be more eager to IFRS. This factor turned out to be

highly significant according to their empirical results.

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To conclude, there is the factor of a favorable political environment. Hassabelnaby, Epps and Said (2003), using an

Egyptian database, conclude that both government and monetary stability could positively affect the development

of accounting systems and furthermore the alignment with other countries. If the legal authorities are well worked

out, they will attach more importance to the accounting quality and are expected to be more favorable to IFRS.

However, there was no empirical evidence for a significant positive relationship between a favorable political

environment and IFRS adoption by developing countries in the paper from Zehri and Chouaibi (2013).

The different factors and their significance in both papers are summarized in Table 2 below.

Table 2: Significant factors determining IFRS choice

6 Benefits IFRS for developing countries

As mentioned above (in section 3), a simple takeover of an accounting system will not be enough for developing

countries (Hopper et al., 2017). Each country needs a system that is adapted to its own environmental and

economic conditions. However, that does not mean that IFRS cannot be useful. It can form the base for

governments and national accounting bodies to create their accounting system, and shape this for their local

situation. Certainly for enterprises operating in multiple countries, the use of IFRS in these countries can increase

comparability (Ahmed et al., 2013).

Still there are both advantages and disadvantages to the IFRS system governments need to take into consideration

for their choice of whether or not using IFRS.

For countries without good accounting bodies of regulatory agencies, a complete acquisition of the IFRS rules for

listed enterprises is definitely recommended according to most literature (e.g., Barth, Landsman, & Lang, 2006).

Furthermore, IFRS can be applied for SMEs, and therefore could be the system for all companies in the country

(IFRS, 2018f). This is discussed in a further on in section 9.

Results of advantages based on developed countries should not simply be taken over for developing countries but

could give an indication. Developing countries could even profit more from some advantages because, with usually

a worse domestic GAAP than developed countries, they have more room for improvements. However, local

circumstances, financial markets legal and political entities and suchlike could block or at least reduce these

advantages (Ball, 2016).

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To start, Fino (s.d.) gives five possible advantages of using International accounting standards like IFRS and IAS for

developing countries, listed based on Belkaoui (1985). First, the setup costs of the standards could be lower

because the use of an existing and widespread system. Second, International harmonization and comparability are

strengthened. Third, more chance on receiving important foreign investments. Fourth, it makes it easier for

accounting professionals to pursue standards of behavior and conduct. And finally, raising the countries’ status as

an important and cooperative member of the globalizing community.

According to a study from Larson (1993), as stated in Fino (s.d.), using the former IAS standards can have a possible

positive effect on economic growth with the condition that the standards should be adapted to the local

circumstances. The discussed advantages below are these most raised in the literature.

6.1 Quality and relating matters

Accounting quality and the associated transparency is one of the main goals of the IASB (IFRS, 2018d).

The most important components of quality can be traced back from the mission statement of IFRS, where they

explain their three key missions that ultimately affect the accounting quality. First, there is transparency, with

accurate and reliable information they want stakeholders to make substantiated decisions. Second, accountability

with the reduction of the existing information gap between companies and their investors. Third, IFRS strengthens

economic efficiency by giving information to capital providers that can help them making accurate investment

decisions and risk estimates worldwide. Cots for this process will be reduced by using one, universal and

understandable accounting language (IFRS, 2018d).

Quality is an important factor for development because credible, high quality financial statements can attract

investors and collaborations. More specifically, it could drive down cost of capital, provide better resource

allocation and increase the global mobility of capital and other resources. Developing countries could benefit the

most from using IFRS because their domestic GAAP often lacks in quality with shortcomings in transparency,

supervision, etc. (Ding, Hope, Jeanjean, & Stolowy, 2007; Soderstrom & Sun, 2008).

Soderstrom and Sun (2008) investigate the change from a local GAAP to generally accepted IFRS. They conclude,

together with the findings of other literature, that there is a positive impact of voluntary use of IFRS on the quality

of accounting information.

For mandatory adaptation, which currently is the case for most countries, I cannot just take over these results.

Accounting quality is determined by more than just the accounting standards being used.

In what follows the different factors determining the accounting quality will be discussed. These factors also are

important for other potential benefits of IFRS in relation to development, like the attraction of Foreign direct

investments (FDI). According to Soderstrom and Sun (2008), there are three main factors affecting this quality of

financial reports: (1) the quality of IFRS or the other used accounting standard, (2) the legal and political decision-

making authorities and finally (3) impulses and incentives from good financial reporting, existence of a (strong)

financial market, capital structure, ownership and tax system. Figure 3 gives a visual representation of these

factors and how they all (in)directly influence the accounting quality.

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Figure 3: Determinants of accounting quality (Soderstrom & Sun, 2008)

This means that adoption of IFRS by itself will not be enough to really affect accounting quality in a significant

manner. As a result of the fact that these other determinants will continue to be highly diverse, the authors argue

that accounting quality in all countries using IFRS will be dissimilar.

For the first factor (1), about IFRS itself, it can be proven that the system has a well worked-out accounting system

that can really enhance quality in comparison to the GAAP used in most developing countries. As mentioned on

their website (IFRS, 2018d), this is the key objective of IFRS and they are constantly updating and enhancing their

standards to keep this high quality up. The key factor of IFRS compared to the other systems is the accountability

and comparability they get from the broad use. This makes it easier for the stakeholders, especially the (potential)

investors, to compare companies across national borders (IFRS, 2018d).

The second factor (2) in Soderstrom and Sun (2008) about legal and political authorities, has many influences on

quality, both direct as indirect. First, they have an indirect impact via the standards (arrow 2 in Figure 3) because

political authorities decide which standards they are going to use in the country and how they are going to

implement them. Additionally, the standard setters are influenced by users of accounting information like banks,

shareholders, labor unions and the political system in general. To reduce these influences a bit, the independent

IASB was formed in 2001, but governments and other political organizations still have major impact. The legal

authorities are also an important influencing factor. As mentioned before, IFRS has big influences from the Anglo-

Saxon common law. In this system the division of the executive and the judicial authority is an important

characteristic, reducing the influence of the government. Standing opposite, there is code law (mostly used in

continental Europe). This system gives governments the power to control both the law development and the law

execution. Accounting systems based on code law have way more political influences and governments tend to use

accounting for tax bases and the division of budget. The flow of impact by political and legal systems on IFRS

mainly come from organizations in developed countries, but ultimately affects all countries using IFRS (Soderstrom

& Sun, 2008).

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The IASB has indicated that it is tackling this problem by allowing members of more diverse geographical and

political backgrounds, especially from developing countries (IFRS Foundation Monitoring Board, 2011).

Now I switch to the influences that are more country-specific (Soderstrom & Sun, 2008). The second effect of legal

and political authorities is their direct outcome (arrow 3 in Figure 3). For example, La Porta et al. (1998), as

described in Soderstrom and Sun (2008), concludes that accounting quality is usually higher in common law

countries and countries with substantial stakeholder protection. The most important contribution of the legal

system in a country to accounting quality is the enforcement power because it must guarantee the correct follow-

up of the accounting rules. This varies significantly across countries, especially comparing developed and

developing countries. This is the main reason why the enhancement of quality by IFRS is sometimes not very

significant for developing countries.

Political systems have similar direct consequences. When the country is known to be corrupt, firms are more likely

to distort the figures in order to get lower tax amounts, government purchases, etc. However, when there is a high

chance of intervention by the government, some companies could have more incentives to show lower profits in

order to drive down taxes. Final point raised is found after researching around cross-listed companies. Countries

where the legal and political system is weaker and investors get less government protection, they tend to charge

higher interests or provisions. This is why developing countries in need of capital should consider stronger

governmental involvement to attract investments and drive down cost of capital. Normally, firms listed across

multiple countries should therefore have higher accounting quality. However, for the investigated case of the US,

the situation is just the opposite (Lang, lins, & Miller, 2013). There it is found that companies only listed in the US

have on average more and better earnings management than their cross-listed counterparts. One possible

explanation for this is that the Securities and Exchange Commission (SEC) is stricter for the pure American firms

than for the cross-listed companies originated in countries with low investor protection (Lang et al., 2003;

Soderstrom & Sun, 2008).

Finally, legal and political decision-making has an indirect effect on accounting quality via the listed impulses and

incentives (3). Through stock market development, the demand for accounting information is influenced.

Meanwhile the stock market itself is determined by political and legal systems and therefore the indirect

relationship (arrow 4 and 5 in Figure 3) is formed. A country can attract a higher number of investors when

governments provide high investor protection and a high Return On Equity (ROE). The poor development and

continuity of stock markets is a major problem for many developing countries (Soderstrom & Sun, 2008).

Below, the importance and relationship between those stock markets and development is discussed.

Stiglitz (1989) argues that stock markets are an important factor in the economic growth of developing countries,

not only through increased accounting quality. They are needed for investment attraction and raising capital

(liquidity function), but also for efficient resource allocation by selecting the right investments and to control if the

investments are well used for the stated objectives. However, he states that just having a working stock market is

much more important than one that is working perfectly.

Opposite to this, Greenwood and Smith (1997) have, like the majority of researchers, a more positive conclusion

about the relationship between good working stock markets and economic development.

21

They argue that expansion and further development of the financial market are key influences for economic

growth. Greenwood and Smith’s (1997) conclusions are based on a wide range of prior empirical research and

their own research design. The underlying causes of this relationship are, quite similar to Stiglitz (1989), good

resource allocation so that capital flows to the most profitable use, risk pooling, liquidity creation by attracting

enough investments, increased specialization thus enhancing quality and supporting entrepreneurial development.

They add that financial markets are important for technical support and development, by bringing in funds for

research but also knowledge from other countries. More on this last benefit is described in section 6.2. Finally,

financial markets are known to have high fixed costs, but with further development the total costs for each market

player could be driven down (Greenwood and Smith, 1997).

Finally, Fredholm and Taghavi-Awai (2006) also conclude a positive relationship between efficient capital markets

and economic development. They state that the quality is often lacking in developing countries and backing this

argument by using a capital market diagnostics (CMD) model with information by professionals in the field.

Financial services are absent or have serious quality defects. That is why organizations like the World Bank give

significant attention to building and enhancing this capital markets in order to facilitate economic development.

Second indirect relationship in Soderstrom and Sun (2008) is through the capital structure (arrow 6 and 7 in Figure

3). Firms with different financing structures will have different impulses for their accounting information quality. It

is generally assumed that reporting quality is less important when bank financing increases. This can be explained

by the fact that outside investors heavily rely on the financial statements to make accurate investment decisions

while banks and other financial institutions can get insider information through meetings with managers. It is

impossible to provide a big batch of shareholders with accounting information through personal communications.

Capital structure does not show major differences between developing and developed countries. It is proven that

capital decisions are mainly determined by the same factors and that the division between equity and debt

financing is similar (Booth, Aivazian, Demirguc-Kunt & Maksimovic, 2001). Still, there are some influences from the

political and legal system on this capital structure. In countries with more corruption and bad systems, accounting

information is less trusted which means that bank financing becomes more important and accounting quality lags.

As already mentioned, these bad government systems will be more frequently the case in developing countries. To

conclude, quality of accounting reports will be worse for countries with more bank financing and political risks

(Booth et al., 2001; Sun, 2005).

The third indirect relationship discussed in Soderstrom and Sun (2008) is through the ownership of companies

(arrow 8 and 9 on Figure 3). First, reporting quality will be lower for companies with more concentrated ownership

than for example public companies. This can be explained by the fact that the owners in private companies can

easily consult a lot of inside information whereby the need of high quality financial reports to make decisions is

lower. Second, if there is a big gap between controlling and minority shareholders, the accounting quality will be

lower. This causes an agency problem where the controlling shareholders have incentives to present the figures

better than they are. What is more, controlling shareholders benefit from presenting steady earnings because they

have long-term interests.

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These long-term profits are expected to be low or negative at first and high in the future, but for the necessary

bank funding stable earnings are better. Finally, foreign stockholders usually demand more accurate accounting

information because they know less about the local institutional situations. Ownership itself is affected by legal

institutions because stronger protection of investors results in more diffusion in ownership. Concentration of

ownership is necessary to compensate weaker legal environments because shareholders need more control to

resist the agency problems with managers and investors with low budgets want to avoid the bigger risks. As for

political systems, getting favors from politicians is easier in more concentrated environments. Lobbying and

corruption is less likely to be leaked and a controlling owner in a concentrated business radiates more confidence

and certainty towards the politicians who can do business with them. This shows another reason why bad legal

and political institutions could damage accounting quality. They usually cause higher concentration because the

lack of investors protection and corruption opportunities (Soderstrom & Sun, 2008).

Finally, the last factor influencing accounting quality and affected by legal and political institutions is the tax

system (arrow 10 and 11 on Figure 3). Tax systems can affect the accounting quality by: (1) if the tax is strongly

based on the accounting figures in a country, earnings are more likely to be manipulated, (2) if the taxes are

higher, this will also increase the chance of reforming the numbers, to decrease the taxable earnings in the books

and (3) if the tax authorities have higher control options, then accounting information will automatically be more

representative. Tax systems are influenced by the legal backgrounds of a country, code law countries have more

conformity between taxes and accounting information than common law countries, while the latter focuses more

on accounting quality for investors. From the view of political systems, corruption can harm the tax system

(Soderstrom & Sun, 2008).

Developing countries using IFRS are often lacking in significant quality injections because their political and legal

institutions do not meet the necessary requirements. The direct and indirect effects on accounting quality are

therefore fallen short. As direct consequence, foreign investments and grants from aid organizations will be lower

(Bova & Pereira, 2012). Buntaine, Parks and Buch (2017a) found that countries with the worst institutions in terms

of corruption and interventions, which can therefore make the most progress in that area, have less chance on

setting targets that could improve their institution quality. They fail to select targets solving their public problems,

improving their institutions and developing the judiciary on the long-term because they only try to signal success

of their institutions by meeting form targets without tackling the core of the problem. Countries more relying on

World Bank support are more likely to just take over from targets which are less likely to strengthen their

institutions than more well worked-out function targets. These findings have implications for development

projects. They need to focus more on institutional performance and targets instead of solely supporting countries

in need with financial aid (Buntaine, Parks, & Buch, 2017b).

Ding et al. (2007) make similar conclusions. They state that accounting standards are not standalone and pure

harmonization of standards (like with IFRS) is not going to solve all quality problems for developing countries on its

own. They focus mainly on the capital market and the legal environment in main factors that are also influencing

the accounting quality.

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These must be adapted to the new situation of IFRS in order to get sufficient quality injections. The desired

worldwide uniformity may not be possible to reach the uniformity objective worldwide because some, mostly

developing, countries fall short on institutional changes (Ding et al., 2007).

Last year’s corruption rates confirm the political backlog of most developing countries. Corruption is noticeably

higher in these countries, like shown in Figure 4 below.

The index is compiled by corruption experts and businessmen. Looking at the years before, hardly any

improvements are made. With more than two third of the countries with a score below 50 and a mean of 43, much

progress is necessary. Reforms of political institutions, for example based on the SDG’s, should be done in order to

grow on a national and international level (Transparency International, 2018).

Figure 4: Corruption perceptions index 2017 (Transparency International, 2018)

To support the vision of lacking legal systems in developing countries, I look at the paper of Weingast (2008). He

argues that developing countries usually decide to resist the rule of law. While knowledge about well-working legal

system is plentiful by looking at developed countries, they fail to implement it efficiently.

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This is due to huge differences in social structure and organization, and the consequent resistance against the legal

systems from developing countries. The commitment to the system is too low and therefore it is impossible to

continue to exist over time. It is unsure for enterprises and other stakeholders to rely heavily on the system

because they cannot count on it to be in operation in the future (Weingast, 2008).

Ahmed et al. (2013) investigated if the accounting quality and transparency of a firm’s financial reports improve

when they are obligated to use IFRS.

They define accounting quality as something that makes it harder for managers to be mysterious about the

accounting decisions or that prevents inflating the numbers of earnings. Their findings clearly conclude better

accounting quality for the investigated firms. The income smoothing is increased with less volatility in net income,

the accrual aggressiveness increases a lot and the third significant reason for this conclusion is that the timeliness

of loss recognition is lower. The study mainly focusses on firms that are not located in developing countries, but

can be generalized to all countries when the rules are monitored and well-respected by the companies in that

country.

Barth, Landsman, and Lang (2006) evaluate the accounting quality by comparing results of IFRS and non-US

domestic standards in 21 different countries between 1994 and 2003. They found that IFRS use causes less

earnings management, more timely loss recognition and more value relevance of earnings. All these effects are

indicators of higher accounting quality, the state that accounting quality increases after IFRS adoption. Managers

have less options to smooth the accounting numbers or commit fraud and the changes in the reporting system

usually causes stricter enforcement and suchlike. This all contributes to better accounting quality. There are two

remarks on this conclusion: First, the domestic GAAP could have a higher quality than IFRS. There are still a lot of

flows related to the new relatively new standards that the IASB has to cope with. For example, as described in Ball

(2006) and further on in this paper (barth et al., 2006), fair value use causes a lot of difficulties that could damage

the accounting quality in comparison to the basic income approach. Second, as discussed before, if the use of IFRS

is not accompanied by strong legal and political enforcement, a lot of the quality improvements can be lost.

Kim and Shi (2012) find that the economic quality of IFRS is on average higher than when the local GAAP is used,

and this conclusion is backed with evidence from the majority of papers they consulted (e.g.,Barth et al., 2008;

Covrig, DeFond, & Hung, 2007; Leuz & Verrecchia, 2000). More firm-specific information is incorporated in the

stock price, showing that the market trusts the information of IFRS more to be credible and transparent. Note that

this study is done on companies with voluntary IFRS adoption, so that only companies with a positive cost-benefit

analysis will have applied it.

Ball (2006) also believes that IFRS will give a pure quality injection to the accounting information. Increased

comparability and reducing of information costs are proof of that. However, these can only be significant if IFRS is

implemented accurately and supported by the countries’ legislations and institutions, as discussed before.

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Bova and Pereira (2012) have a rather divided opinion about the pure quality injection IFRS can give. First, they

give some reasons of why this quality is so important for full IFRS. The system is mainly built for public companies

to enforce comparability (except for the separate rule for SMEs, discussed later on). These companies are highly

dependent on public investors who have higher demand for high-quality accounting information than the investors

in smaller and private companies. The demand factor for higher quality is necessary for the investors to reduce the

information risk. Information quality and the higher transparency that follow are the most important drivers to

choose IFRS. Note to this conclusion is that Bova and Pereira’s (2012) investigated sample only consists Kenya.

However, Kenya has many characteristics that are equal for other developing countries.

An important conclusion Bova and Pereira (2012) made, based on other investigated papers, is that IFRS will

usually enforce the quality of financial reports, but only when and for the amount that it is better than the local

domestic GAAP. This is mainly due to the increase in transparency and comparability. Both will help the

information environment and ultimately reduce the adverse selection costs and estimation to gain capital. The

ultimate benefit they will get is a lower cost of capital, which is further discussed in part 6.2 about foreign

investments.

Despite these many positive signals, this Bova and Pereira (2012) give some opposing arguments on the broadly

accepted assumption that IFRS will enhance the reporting quality of developing countries. First, the real quality

injection of disclosure is driven by reporting incentive and if the costs to disclose everything conforming IFRS is too

high in comparison to the reporting gains, the transparency and quality gains may be low or even nonexistent.

Second, if the follow-up and support from government and other leading organizations for IFRS is low, a lot of

entities would not have full compliance of IFRS. Third, the costs of compliance could be too excessive for a firm’s

accounting budget causing again a low compliance. The last reason that can disprove this assumption is that many

components of the domestic GAAP could be better adapted to the local situation and ultimately make this GAAP

better than IFRS for the quality and transparency of the accounting information in developing countries (Bova &

Pereira, 2012).

Concluding, the majority of studies shows that IFRS adoption provides a higher quality of accounting information,

both for developed as developing countries (e.g., Ahmed et al., 2013; Barth et al., 2006; Kim & Shi, 2012;

Soderstrom & Sun, 2008). However, in order to have a big, significant impact on quality injection, other factors like

good governmental organizations and incentives are necessary. The fact that legal and political entities in

developing countries often lack to in(directly) enhance the accounting quality, is discussed. They fail to improve

their systems because of wrong targets and ironically sometimes because of the assistance of aid organizations

(section 8). The differences between developing and developed countries for the different incentives are mainly

due to the legal and political systems. Because of this, the quality injection of the system of IFRS alone does not

provide most developing countries with the necessary degree of accounting quality. However, they could

potentially achieve the greatest quality gains because of the bigger gap between their domestic GAAP and IFRS

(Ding et al, 2007; Soderstrom & Sun, 2008).

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The minority of literature opposes the view that IFRS itself could enforce accounting quality in developing

countries and sees no improvement at all in accounting quality after IFRS use (e.g., Bova & Pereira, 2012). Main

reasons are the weak enforcement of legal entities and the excessive cost of compliance and implementation.

Furthermore, IFRS might not be adapted enough to other specific local conditions like main businesses and

important stakeholders. Finally, the quality of the older domestic GAAP could be better, but this is almost never

the case for developing countries (Bova & Pereira, 2012).

The main benefits in case of development that follow increased quality are the expected increase of foreign

investments, lower cost of capital and better and more accurate decisions in companies (e.g., Daske, Hail, Leuz, &

Verdi, 2008). These benefits are described in the next sections.

6.2 Effects of implementing IFRS on Foreign investments

In this section I will discuss if using IFRS has an effect on FDI, market liquidity and ultimately on development.

Some related literature and conclusions are already dealt with in the previous part and will be briefly repeated

here. First, I will have a look at different papers to evaluate if increased FDI could help a developing country in

their growth and second, if IFRS implementation boosts these foreign investments. IFRS is expected to increase

market liquidity and lower the cost of capital, due to the higher accounting quality discussed above (Hansen &

Rand, 2006). FDI to developing countries have risen dramatically since the 1980s and are expected to continue to

grow as globalization keeps on extending (Economics Online, s.d). Local investments could also increase due to

IFRS implementation, but these are less substantial and important for the economic growth of developing

countries (Daske et al., 2008). Furthermore, this domestic investment increase is hardly discussed in academic

literature.

In the literature, a positive association between FDI and development is increasingly accepted (e.g., Hansen &

Rand, 2006; Nair-Reichert & Weinhold, 2001). This assumption is based on two important positive influences

resulting from foreign investments. First, it can accelerate the knowledge and technology transfer from developed

to developing countries, which causes a productivity and efficiency rise in the domestic companies. Labor training,

new management practices, new technologies… could all be transferred through the channel of foreign

investments. E.g. for the new technologies, capital was needed to implement them and not really to invent them

since most were already developed, but not in use. Second, foreign aid is an important element to fill deficits in

the current accounting balances of developing countries. Extra foreign investments will drive down the average

cost of capital for the domestic firms. Countries and their companies need the resources to invest and

consequently to grow. Certainly if they follow the classic path from agriculture to industrialization where many

resources are fundamental. Both private investments and public development assistance like loans or grants could

be major influences for further economic development. Private investments provide a whole range of new and

better resources like capital, technologies, managerial and employee skills, new products, higher efficiency and so

on. The public grants increase the too low stock of resources which most developing countries are dealing with.

The latter is a big point of discussion, as described before and in part 8 about the World Bank. Also, the expected

positive relationship between foreign private investment and development is not found in all studies, there is still

27

some discussion about this in the literature and also about the size of the relationship (e.g., Zhang, 2011; De mello,

1999). Even more, the question about the causality should be asked (Hansen & Rand, 2006). If there is a positive

association, does FDI really positively affects economic growth or does the relationship only exists because

countries with faster growth easier attract these FDI? The key argument against the positive relationship is that

the balance of payments could get worse because profits will be moved elsewhere with negative consequences of

the competition in the domestic market. Another important drawback of an increase in FDI is the partial loss of

political sovereignty because they need to rely too much on the financial flows of big International companies

(Buntaine et al., 2017b; Fino, s.d.; OECD, 2002).

Hansen and Rand (2006) investigate the relationship between FDI and development in 31 developing countries

over 31 years and find a strong relationship between FDI and economic growth, both in the short and in the long

run. Even more, they conclude the causality from FDI to the economic growth. The relationship is independent

from the existing level of development and therefore indifferent in different countries and regions.

The OECD (2002) mainly agrees with these conclusions, with the exception of the equal strength across countries.

Their report confirms that most studies conclude a positive relationship between FDI and economic growth

(through factor productivity and income growth). They argue that in the least developed countries, the positive

effect is the smallest, yet it still exists. Bad working legal and political entities and stock markets, supplemented by

a low development in technology, education and infrastructure, ensure that many positive benefits of the FDI flow

are lost (OECD, 2002).

Nair-Reichert and Weinhold (2001) also concludes in their investigation of 24 developing countries an on average

positive causal relationship between FDI and development. However, this relationship shows strong differences

throughout the sample. If an economy is more open, the FDI impact on economic growth can be assumed to be

larger on average.

Zhang (2001) tests the causal relationship on 11 developing countries from East Asia and Latin America. His

findings are rather divided. Only five of the 11 investigated countries did show a significant positive effect from FDI

on economic growth. He therefore concludes that the effect is strongly depending from country-specific economic

factors. In his rather small sample, the East Asian countries tend to have a more positive impact than those in Latin

America and the relationship is usually stronger when there is stronger education quality growth, high FDI export,

control a stable economic environment and have more liberal trading conditions.

Finally, De Mello (1999) only finds a positive causal relationship for the 15 investigated OECD countries. For the 17

investigated non-OECD countries, all under the definition of developing countries, no positive causal relationship

was found. What is more, on the short-term he concludes a negative impact from the FDI on development. Again,

in this paper big differences are perceived between different countries regarding this relationship.

Despite some divided views (e.g., De Mello, 1999; Zhang, 2001), most literature about development finds a

positive causal relationship from FDI to development (e.g., Hansen & Rand, 2006; Nair-Reichert & Weinhold, 2001;

OECD, 2002). However, this relationship is in most papers strongly different across countries (e.g., Nair-Rechert &

Weinhold, 2001; Zhang, 2001).

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Strong institutions and smooth working financial markets are crucial, otherwise investments cannot easy be

transferred. Furthermore, as mentioned in part 3, the SDG’s from the United Nations are also concerned about the

accounting quality because they see the resulting investment gain as a key factor for development (Makarenko &

Plastun, 2017). The question now is if IFRS really causes an increased flow of foreign investment.

As discussed above, IFRS is generally believed to, at least partially, bring the accounting quality to a higher level.

The increase in transparency, accountability and efficiency should help investors taking decisions and lower the

cost of capital (IFRS, 2018d).

Harmonization of accounting standards can increase transparency for investors, information asymmetries can be

lowered and risks and opportunities are easier to observe by investors. In summary, the information acquisition

costs for investors worldwide are lower. The assumption is that this should lead to higher foreign investments by

other businesses and individuals (Daske et al., 2008). That is why developing countries, which usually have or had

poor transparency in comparison with the IFRS transparency, have the biggest potential to expand their foreign

investment stream by implementing IFRS. However, it is mainly these countries that are least likely to benefit from

IFRS adoption and higher FDI due to poor local conditions (Gordon et al., 2012).

Former Ernst & Young chairman and CEO Jim Turley supports this reasoning and therefore encourages developing

countries to apply IFRS. In an article in the Wall Street Journal of November 2007 he states: ‘There would also be

benefits for emerging markets and the poorest countries of the world. A globally embraced set of standards can

provide a readily available foundation for capital market activity. This could promote investment, strengthen the

economy and improve people’s lives.’ (Turley, 2007, p. 18).

DeFond, Hu, Hung and Lu (2011) investigate the consequences of using IFRS on cross-border investments by

increased comparability. They use a sample of European countries, which can be interesting because the EU was

the first to use IFRS and there is most information on these countries about the effects of IFRS use. Their findings

suggest that IFRS use indeed improves the foreign investment flows, but only for companies and countries with

strong credibility in a good implementation of the accounting rules (DeFond et al., 2011).

Daske et al. (2008) have done research on the mandatory use of IFRS. They conclude that, on average and

significantly, market liquidity increases and cost of capital decreases (although the latter could be already before

the switch because of market anticipation for the new system) due to higher accounting quality after mandatory

IFRS implementation. The most important condition for this relationship to exist is again that strong legal and

political enforcement is present in the country and that there are incentives to report transparently and reliably.

Besides this, they also find effects to be bigger for voluntary adopters (but mind some self-selection effects), for

countries with bigger differences between IFRS and their local GAAP combined with strong institutions and for

members of the EU (Daske et al., 2008).

29

Chen, Ding and Xu (2011) investigates the IFRS-FDI relationship through a sample of 30 OECD countries by

investigating a time series between 2000 and 2005. These countries are mainly developed so the results cannot

just be generalized for developing countries but can give an indication. They conclude a significant positive

relationship meaning that the switch to IFRS increases the flow of foreign capital because of the reduction of

information asymmetry. They state that implementation of IFRS ultimately provides a lower cost of capital. They

also find a stronger relationship between countries with bigger institutional differences because then good quality

accounting information is more important as substitute. With these results, the authors suggest that policy makers

of non-using IFRS countries should start using the accounting system.

Gordon et al. (2012) use a broader sample with observations spread over 124 countries to test the relationship

between IFRS and FDI. Furthermore, they are one of the few that also discuss the differences of this relationship

between developing and developed countries. Like most other important studies, the presumed overall positive

relationship between IFRS use and total foreign investments for a specific country is encountered.

However, in their study, this relationship is only statistically significant for developing countries and not for

developed countries (Gordon et al., 2012).

With their conclusion of a significant relationship for developing countries, researchers and policymakers should

take this into account for their decisions. Some of them wrongly assume that foreign investments are neutral to

the effect of financial reporting standards, but the conclusions in the papers discussed points out a giant argument

in favor of adopting or continuing to use IFRS. Moreover, the relationship between getting money from

international lending organizations like the World Bank and using IFRS, apart from some other factors not

investigated in this paper, is also significantly positive. This also suggests that countries without IFRS should

consider using it if they rely heavily on receiving external funds from these organizations (Gordon et al., 2012).

Ramanna and Sletten (2007) investigates if countries are more prone to use IFRS when the expected

abovementioned relationship about having more foreign investments after IFRS use is stronger for their particular

case. They do not find any evidence that this relationship exists, which could implicate that policymakers do not

take increased foreign investments into consideration when determining their accounting policies. This could be

the case even though many studies indicate that this investment factor is one of the most important factors for

economic growth, so a change in mind could be necessary (Romanna & Sletten, 2007).

Not all research agrees on the positive effects of IFRS on foreign investments. Lasmin (2012) concludes that there

is no significant positive relation for developing countries. Lasmin (2012) blames this on the fact that IFRS is mainly

worked out by members of developed countries and therefore it is not adapted to the specific needs of developing

countries. Furthermore, simply the adoption of IFRS is not enough, but there is also need of strong legal and

political entities, good corporate governance, strong internal controls and regular screenings. This points at the

same problem earlier discussed in this paper about accounting quality, stating that IFRS alone will not have a big

impact (e.g.,Ball, 2016).

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The study from Owusu, Saat, Suppiah and Siong (2017) is a more recent research on the effects of IFRS on FDI,

focusing on 116 developing countries between 1996 and 2013. They find no significant relationship from IFRS on

its own, but in combination with good institutional quality there was a significant positive relationship perceived.

The most important economic benefits of using IFRS as described in the other papers (e.g., Ball, 2006; Barth et al.,

2006; Defond et al, 2011) will only occur when the countries’ institutions are well worked-out and trustworthy.

Owusu et al. (2017) really want to stress the importance of the interdependencies between institutions and

accounting standards, suggesting that standard setters need to take this into account regarding their decision-

making.

The use of IFRS is only one of the factors influencing FDI. In the discussed studies, other factors are also included in

most models, but this means that all results should be interpreted with caution. Problems like omitted variables,

isolating this one factor afterwards and data limitations should be taken in mind (Owusu et al., 2017).

A big problem for developing countries can be the efficiency of the financial market. Often these markets are not

developed enough or not trustworthy in developing countries, which blocks the path for both domestic and mainly

foreign investors to invest in companies in these countries. This is extensively explained in section 6.1 (e.g.,

Greenwood & Smith, 1997). With different effects on quality and investments, governments should focus on the

implementation of a good-working financial market.

To conclude this, I could first say that most research find a positive relationship between higher FDI flows and

development, although I have to put this into perspective for developing countries (e.g., Hansen & Rand, 2006;

Nair-Rechert & Weinhold, 2001; OECD, 2002). With that in mind, I checked if IFRS use could deliver these higher

foreign investments and associated with this a lower cost of capital, especially for developing countries. Most

literature confirms that this is in fact the case through higher accounting quality, although it depends on some

important factors like institution quality and financial markets (Chen et al., 2011; Daske et al., 2008; Gordon et al.,

2012, Owusu et al., 2017). This can be traced back from part 6.1 about accounting quality because that is the basis

for potential higher FDI flows through the higher delivered transparency and credibility of the accounting

information and tackle the information asymmetry. This causes heterogeneity in the capital market effects

between different IFRS users. Developing countries using IFRS or planning to use it should enforce or adapt their

institutions to get all economic benefits from the accounting system. Their domestic GAAP usually has bigger

differences with IFRS causing the potential capital market benefits of implementing IFRS to be higher when well-

supported.

6.3 Other benefits for developing countries

Another advantage arising from the expected quality injection of accounting information through IFRS use (e.g.,

Soderstrom & Sun, 2008) is better decision-making by companies. With higher accuracy of the information, it is

easier to estimate the real economic situation of the firm and offers managers the opportunity to make decisions

based on that data. Disciplines like management control to motivate employees also get a boost from this.

31

Furthermore, they can more easily compare their financial statements with competitors, both domestic and

foreign. The SWOT analysis (Strengths, Weaknesses, Opportunities and Threats) and benchmarking can be

enhanced by using the accounting information from IFRS (Persic, Jankovic, & Vlasic, 2013).

This advantage is not concluded in all situations. Cohen and Karatzimas (2013) have done research on the impact

of IFRS on managerial decisions in Greece. They conclude that IFRS delivers only moderate and no significant

effects on better managerial information. However, the more it is implemented as something to enhance the

efficiency of managerial decisions, the more the management decisions will be influenced by it and the more it will

be used for staff reviews. These findings are only based on Greek companies and cannot just be used for the

situation in developing countries, where there is a need for extra research on this subject (Karatzimas, 2013).

One of the most important reasons to choose for IFRS in developing countries is the lack of the existence of a

(good) accounting regulation. Instead of the development of a whole new system or make significant changes to

the bad existing one, countries can start from IFRS. If properly implemented and monitored, developing countries

could benefit most from the new system in terms of quality injections, higher FDI flows, lower cost of capital…

because of the larger gap with their older accounting system (Thompson, 2016).

IFRS use also will help to attract multinational companies to settle because their financial reporting in the different

countries could be done similar instead of using different domestic systems. This is an important factor to create

employment opportunities. Curiously enough, this advantage is not discussed in a lot of literature

(Tyrral, Woodward, & Rakhimbekova, 2007).

Another positive factor is related to 6.1 about accounting quality and comparability. Apart from the discussion

about the actual existence of the advantages, the success of the system cannot be denied. Over 140 countries

using the system and other important regulations like the US GAAP are converging with IFRS. This success indicates

that the comparability advantage is increasingly applicable (Ball, 2006).

Above discussed advantages are important in the consideration of IFRS implementation by governments. The most

important ones are the quality injections and the higher FDI flows, if these apply to the country (Hansen & Rand,

2006; Soderstrom & Sun, 2008). Better internal decisions (Persic et al., 2013), having a substitute for their weaker

existing accounting system (Thompson, 2016), attracting multinationals (Tyrral et al., 2007) and worldwide

comparability (Ball, 2016) are some of the other possible benefits.

Of course, governments of developing countries should also consider the negative consequences of IFRS use

(Jermakowicz, Prather-Kinsey, & Wulf, 2007). These are discussed in the next section.

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7 Issues and costs IFRS for developing countries Although having a lot of advantages, applying IFRS can cause some major issues for countries and the local

companies. It is a system designed in more advanced economies, so the primary focus is not on developing

countries which could harm the advantages. Furthermore, even though it is a widespread and popular system in

these developed countries, these countries still cope with some major shortcomings. Some of these disadvantages

are already shortly described in section 4.2 about IAS 41 because they are relevant for both the whole IFRS system

and that specific standard (Aryanto, 2011; Elad, 2004).

Jermakowicz et al. (2007) summarize the main issues of IFRS as follows, based on unanimous answers on their

German survey:

● Big complexity with a big scope and a lot of different disclosures, rules…

● Costs of implementation are much higher than other systems + costs afterwards with constant revisions

● Lack of guidance for good implementation

● Earnings become more volatile

7.1 Costs before and after implementation

The biggest point of criticism is that the system is way too theoretical and not adapted to use in practice (Pawsey,

2017). The implementation phase lacks guiding and is very costly. As investigated in Pawsey (2017), the change

from an older accounting system to IFRS has big effects on companies, both in the lead up to adaptation and

thereafter. Most countries using IFRS made it mandatory for their listed companies, meaning they have no other

choice than carrying the linked costs (IFRS, 2018a).

All countries and their companies used their own domestic GAAP before switching to IFRS. This switch could be

very costly because IFRS is usually more complex with more disclosures and rules. Especially for smaller

companies, the switch can claim a large part of their budget (Pawsey, 2017). Extra incurred costs for companies

are mainly staffing time to train employees using the new system, consulting and auditing costs, system costs to fit

IFRS and finally opportunity costs through the use of financial resources for IFRS use and understanding instead of

using it for other activities. In Pawsey’s (2017) paper, the cost before, during and after adoption of IFRS were

investigated by sending surveys to the biggest 400 stock listed Australian companies, where IFRS use is obligated

since 2005. However, the authors are convinced these costs will probably be seen in every country where IFRS is

used and can use the paper for an accurate time and cost estimation. They included that all these phases were

very costly, both in terms of costs and time. Not here is that this is in comparison to the Australian GAAP and that

the costs for these big companies are rather irrelevant in comparison to the sales numbers of these big companies.

Although the costs are higher for large companies, these extra costs could still be significant in comparison to

other accounts for smaller companies. The costs in the lead up to and the adoption itself could be summarized as

follows:

● Upgrades from IAS rules

● Training and development employees

● Informing stakeholders and other accounting information users about IFRS impacts

● Putting in order opening balances and comparative figures according to IFRS

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On average, the implementation costs were around 200.000 Australian dollar (around €130 000 with the exchange

rate of May 2018) with a maximum of 9,5 million Australian dollar (around €6,15 million) (Country Currency Rates:

Currencies conversion and daily updated exchange rates, 2018; Pawsey, 2017).

Also after implementation, costs will be higher because of the complexity, the revisions and updates. The most

important components of this costs are:

● Continuous training and developing employees

● Cost to external auditors and specialists

● Extra costs for financial statements preparation

The survey estimates a total cost increase of 20% or more each year (Pawsey, 2017).

De George, Ferguson and Spear (2013) also conclude that there are significant observable costs related to IFRS use.

While they also use a dataset of Australian companies, the results are relevant for all IFRS users. In the year of

implementation, there is an average cost increase for auditing of 23%. Note that only 8% of this increase are

abnormal costs due to IFRS implementation while the other part is wage related. Furthermore, smaller companies

also have a fixed cost increase effect. Their audit fees increase proportionately a lot more compared to those of

bigger companies. De George et al. (2013) do not research other implementation costs but assume that these are

less important than the researched audit costs.

Jermakowicz et al. (2007) confirmed in their investigations for German firms on the DAX-30, that IFRS adoption can

be very costly. However, they believe that the potential benefits far outweigh the costs.

Transparency and comparability with bigger explanatory power of income are listed as the main benefits and

tested to be significant. Moreover, as mentioned in the paper, many researchers conclude that implementation

costs of IFRS are lower than these of US GAAP because in that system is a bit ‘over-regulated’ (Jermakowicz et al.,

2007).

Christensen (2012) argues that costs are highly based on the low voluntary adoption of IFRS by firms, based on the

paper of Kim and Shi (2012). He also shows that the voluntary adoption was higher for firms in countries with

stronger political and legal enforcement.

Most studies conclude a significant cost increase for using IFRS, certainly for the implementation (e.g., De George

et al., 2013; Jermakowicz et al., 2007; Pawsey, 2017). However, these costs are, especially for big companies, not

significant compared to total revenue. Also, if the advantages like quality injection and increased FDI flows are

assumed to be present for the country, the benefits outweigh the costs (Jermakowicz et al., 2007). Studies on the

specific costs for developing countries are not widespread yet, but it could be assumed that implementation costs

for these countries will be bigger because the discrepancy with the old standard is usually bigger. Next, I am going

to discuss the disadvantages of IFRS especially for developing countries.

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7.2 Specific disadvantages for developing countries

The theoretical advantages of IFRS are not always found in practice, because most standards are not adapted to

the local situation of developing countries. Certain advantages for multinational companies or companies in

developed countries will be lost in developing countries because (1) they do not have a lot of influence in the

development process of the standards, (2) the standards are not adapted to the local economic and political

situations which could be vastly different and (3) they have much bigger switching costs because of the

groundbreaking differences with their old standards (Lasmin, 2012).

As mentioned before, implantation, daily use and follow-up of IFRS is fairly expensive. It could be even bigger cost

for developing countries because of poor governance. The practical implementation might be very different from

the theoretical one because of poor institutions, fraud, lack of knowledge… (Lasmin, 2012).

Tyrral et al. (2007) discuss the IFRS implementation for Kazakhstan and the consequences linked to this. There are

a lot of similarities with other developing countries, certainly other former soviet countries, so that these results

could be partially generalized here. The main disadvantage of the system can be traced back to the transition

costs. The majority of surveyed companies (54%) finds the transition very costly, and the majority not agreeing

with this states that the costs are high but necessary to get the future benefits. The types of costs are similar to

those discussed in section 7.1. Another issue discussed in Tyrral et al. (2007) is the lack of IFRS knowledge for the

whole staff and employees involved. The lack of quality teachers and good textbooks in developing countries

causes implementation issues and problems for the good compliance of the rules, both affecting the accounting

quality. Computer systems and accounting programs are usually not adjusted to use IFRS, triggering the need for -

the not always available- IT specialists.

The first kind of problem with the implementation is that the mandatory adoption has been postponed several

times for Kazakhstan and other developing countries. For smaller companies, this implementation is even more

difficult because of resource constraints (Tyrall et al., 2017).

Another big issue is the problem of bad legal and political institutions, this is already discussed in section 6.1

(Transparency International, 2018; Weingast, 2008). Support and control are essential factors to make the IFRS

system work efficiently.

Language and translation problems used to be a large issue for a lot of developing countries. In the beginning, only

the English versions of the standards were available, and this made the implementation even harder and caused a

lot of errors in the execution. The IASB tackled this problem by establishing the Translation, Adoption and

Copyright (TAC) team. Today, IFRS is translated to a wide range of languages and the TAC team is constantly

looking to eliminate the language barriers and translating the new updates (IFRS, 2018e; Tyrral et al., 2007).

Ball (2006) adds some other issues to IFRS use. His main concern is about fair value accounting, as discussed in

section 4.2 about IAS 41. Many of the standards in IFRS are based on this system and the IASB is planning on

expanding the use to other standards because it contains more economic relevant information, with potential

quality benefits as described before.

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However, the number of problems related to this system in practice are high: (1) there is uncertainty about fair

value because of excessive market liquidity, (2) managers can easy influence fair value measurement on illiquid

markets by trading, (3) fair value could be a pitfall for financial crises because companies sometimes use fair value

to present things better than they are, (4) without accurate similar market prices available, estimates are made by

the firm that produces ‘model noise’ and (5) managers could manipulate the numbers by the choice of the model

and the estimates of the parameters. For developing countries, these problems could be even worse because they

usually have less comparable liquid markets to get information from and have less knowledge about accurate fair

value calculations. The last issue about fair value is a big danger in developing countries: volatility. This can be an

advantage, but not when it is caused by model imperfections or manipulations by managers (Ball, 2016).

Although it is hard to give a good overview of all the possible costs and disadvantages of IFRS for developing

countries, literature generally sums up similar aspects. First of all, the cost, both for switching and for maintaining

the system, is the main concern for all countries using IFRS (e.g., De George et al., 2013; Jermakowicz et al., 2007;

Pawsey, 2017). Other issues discussed are the lack of knowledge, affecting the accounting quality (Lasmin, 2012),

implementation difficulties (Tyrall et al., 2008), bad legal and political institutions (e.g., Transparency International,

2018; Weingast, 2008) and difficulties concerning fair value use (Ball, 2006).

Due to these more specific issues, the perceived advantages-costs comparison of IFRS is usually lower for

developing countries (Lasmin, 2012).

Thompson (2016) tries to give an overview of the costs-benefit trade-off for IFRS for developing countries, based

on other research in the academic literature. He concludes that the total possible benefits are higher than the

costs and issues, but only with good implementation and effectuation. Education and legislation need to be

shaped to comply IFRS and the infrastructure need to be sufficient in order to get all the benefits.

Resource aid from international organizations like the World Bank, discussed in the next part, is also necessary to

support the adoption.

For long-term effects we will have to wait for future research because IFRS adoption is a rather recent

phenomenon and research can only draw conclusions for most countries over less than 10 years.

8 IFRS and the World Bank

The World Bank has already been mentioned above. It is an important organization for financial and technical

assistance to developing countries. Its main goal is to support development and to reduce poverty. With low-

interest loans, zero to low-interest credits, and grants, it is an important supplier of financial resources for

developing countries. Furthermore, the World Bank assists them with policy advice, research, analysis and

technical assistance so these countries can do more self-sufficient (The World Bank, 2018).

The question that can be posed is what the relationship is between the World Bank and the IASB foundation. Are

they backing the IFRS rules and do they take them into consideration when making their financing decisions?

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According to multiple articles and sources on the site of the World Bank, IASB and the World Bank have a strong

cooperation with a common goal to encourage developing countries using IFRS. In May 2017, they signed a

cooperation agreement, a Memorandum of Understanding (MoU). The World Bank believes in IFRS to be a system

that with its transparency, accountability and efficiency can strengthen economic growth mainly by attracting

more foreign investments (The World Bank, 2017). Their common target goes further than only getting developing

countries to use IFRS, this is also evident from the priorities listed in the MoU:

● Development of educational programs to teach the users about IFRS standards and documents to support

the implementation.

● The elaboration of these programs to support development projects in individual countries or regions.

● Getting less-developed countries to be more involved in the standard setting procedures of IFRS

(The World Bank, 2017)

Michael Prada, chairman of the IFRS foundation said about the cooperation:

‘In recent years, we have seen a large number of developing economies adopt IFRS Standards. However, many of

these countries need an additional support when adopting IFRS Standards or implementing major changes to

those standards. Deepening cooperation with the World Bank is an obvious way to achieve this goal, and we are

grateful to the World Bank for its active support and fully committed to make this joint endeavour a success.’ (The

World Bank, 2017).

With this statement, the IFRS foundation confirms the important assumption that IFRS rules alone are not enough

for developing countries, the adjustment to the local situation and assistance for implementation is also necessary.

Especially for the latter issue, the World Bank needs to interfere.

The World Bank also developed a practical guide for IFRS use in cooperation with an important banking group to

look at it from a different point of view. This guide tries to provide a more comprehensive and practical vision on

the standard and its supporting materials. It also includes some simple examples to make the execution easier to

understand (Van Greuning, Scott, & Terblanche, 2011).

The encouragement for developing countries to use IFRS is also apparent from the case of Kazakhstan where IFRS

adoption was an important condition to get financial aid from the World Bank (Tyrral et al., 2007). Gordon et al.

(2012) argue that IFRS use has a positive effect on the amount of grants and aid developing countries get from

organizations supporting development like the World Bank.

Furthermore, the Bank gives resources to some countries to support them in implementing IFRS, something that

could be essential for some countries lacking in resources to spend on these accounting issues (Tyrral et al., 2007).

Ironically, some authors claim that the World Bank can even counteract the development process (Eiras, 2003).

The World Bank only hands out funding when there is a well-prepared plan and clear, observable objectives.

Future projects are dependent on whether or not these objectives were met. One of the fundings the World Bank

gives out is for a well worked-out IFRS implementation plan by a developing country.

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Buntaine et al.(2017a), as mentioned before, prove that this pure observable target-setting could slow down

development and damage governmental performance. Developing countries are more eager to select easily

achievable goals which will not enforce the legal and political institutions that play a crucial part in development.

They only try to point out good performance, without really addressing the problems. For example, they could

implement IFRS rules and show this to the World Bank, but without good monitoring as a result of which the

effective implementation is inadequate. Countries with the greatest development delay and need for funding are

least prone to develop goals that can really help enforcing their institutions.

A second weakness of the World Bank is that because of their funding, governments are more likely to restrict

economic freedom and commit corruption, which strongly impedes the development process. Note here is that

the focus of the World Bank is increasingly on advice and support and not only on funding (Eiras, 2003; The World

Bank, 2010).

The World Bank is important for development by providing developing countries with resources. Through their

strong cooperation with the IASB and the setting of resource conditions in favor of IFRS, the Bank promotes the

system. Their belief in the notion that IFRS is a factor in achieving economic development is strong. Resources

from the World Bank are important for future growth of developing countries, but it can also help to provide the

necessary resources to implement the IFRS system (Gordon et al., 2012, Tyrall et al., 2007). However, it is

important to know that the World Bank could also have destructive effects on development. Reformation of the

World Bank, with more focus on the support of implementation, could be desired to better execute its role as

development assistant. In that case, the World Bank needs to be aware of how IFRS is implemented and supported

in developing countries (Buntaine et al., 2017a, Eiras, 2003).

9 SME standard

When full IFRS became widespread, the demand for a standard adapted to the specific objectives of SMEs

increased. There are some major differences between SMEs and other companies, first of all they do not have

public accountability. They have a different user base close to the enterprise, they cope with less complicated

situations and finally they usually have less resources. The full use of IFRS was too complex and detailed for these

smaller companies so countries kept their own standards for their SMEs (Pacter, 2014).

Three main reasons were given to establish this standard: simplification of accounting for these companies, higher

comparability for SMEs mutually and reducing the costs for auditing and training to gain full understanding of all

IFRS rules (Pacter, 2014).

In July 2009, the IASB issued their new standard for general purpose financial statements and other forms of

financial reporting for SMEs. Some changes made for SMEs were eventually also adjusted for full IFRS (IFRS, 2018f).

While more and more developing countries are applying IFRS for their listed and big companies, the application for

their SMEs is lagging in certain regions. However, considering the recency of the standard, the application is

already widespread. As you could see in Figure 2 in section 2 (IFRS, 2018a), unlike full IFRS, the standard is mainly

used in non-EU and developing countries.

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A big part of Latin America and multiple countries in South Africa are using this standard already, and a lot of other

developing countries are considering allowing their firms to use IFRS for SMEs. The lack of developed countries

using the standard could affect the IASB’s objective of global usage and comparability. The EU was an important

driver for the widespread adoption full IFRS by being the first to obligate their public firms to use the system.

Nevertheless, they decided not to implement the SMEs rule because of various reasons as mentioned in Masca

(2012). In summary, the restraining factors are the remaining complexity, big switching costs, too big challenges

for smaller companies because the rule is based on full IFRS for big companies and most importantly the

geographical and cultural differences between countries which matters more for smaller companies because they

are more region-specific (Masca, 2012).

From the countries using the standard, the vast majority (57 for the situation in 2015) allow the use while only a

small part (6 in 2015) require their companies to use it. Making this an option allows the SMEs to make a cost-

benefit trade-off between the several allowed regulations (Kaya & Koch, 2014). Countries have an option to use

only this standard and not using full IFRS for public entities, but currently no countries are opting for this

combination (IFRS, 2018a).

The small separate standard is based on the principles and basics of the full IFRS standards, but it is adapted to the

specific situations of SMEs. The five major simplifications made in comparison to the full IFRS standards can be

summarized as follows:

● Irrelevant topics for SMEs eliminated

● Some accounting policies deleted in favor of easier methods applicable for SMEs

● Simplification of a lot of recognition and measurement policies

● Number of mandatory disclosures has dropped significantly (about 90% less)

● All texts are rewritten to more plain, understandable English for easier use and translations

An important characteristic of this SME standard is that it is ‘self-contained’, meaning that users never have to

consult the full IFRS standards, which has the advantage that they need less knowledge about IFRS. To continue

the simplicity and stability objective, they only make changes to the standards once every three years.

Now the question can be asked why developing countries would choose to implement these rules for their SMEs

(IFRS, 2018h).

Pacter (2014) discusses the development and benefits of this new standard. In the beginning of this discussion in

2003, the board members acknowledged that the existing set of IFRS standards could be applicable for all entities,

including SMEs. However, they also agreed that SMEs needed some modifications to suit for the needs of their

different users and the lower budget they usually allocate to financial reporting and accounting knowledge. The

benefits listed by Pacter (2014) are mainly the benefits mentioned earlier for use of full IFRS. The most important

one is to raise more capital by higher loans and grants. Others are higher comparability, often improved quality

compared to the former national GAAP, reduced burden in countries where full IFRS is already in use for listed

companies and finally a lot of implementation materials and support and training programs from the IASB,

39

which is often lacking in national GAAP. Note that comparability principle will be lower than for full IFRS due to the

lower use of the standard worldwide (Pacter, 2014).

Samujh and Devi (2015) describe the challenges of this new standard. The ‘one-size-fits-all’ approach is heavily

criticized because it is not adapted to the local situation SMEs do business in like cultural practices, regulatory

environment and stakeholder needs. Without major modifications for these local characteristics, the standard

would contribute very little to economic growth and entrepreneurial activities. On the contrary, it could rather be

considered a burden for these objectives. Heavy investments in business infrastructure is a priority before this

standard can be accurately implemented (Samujh & Devi, 2015).

Sellami and Gafsi (2018) discuss the reasons why developing and emerging countries are using IFRS for their SMEs.

These SMEs have become increasingly important for economic growth and other challenges these countries are

coping with. For instance, in Ghana they account for approximately 70% of the Gross Domestic Product (GDP), in

South Africa for around 54% and 52% on average for the Asian countries. Sellami and Gafsi (2018) suggest some

big advantages that could be linked to the use of the standard. First, specific SME investments should be easier to

attract. Second, it would provide a reliable system to make managerial decisions and finally, the financial

statements should be easier to read for the users. However, there are also a lot of opponents of this standard

stating that many other domestic used standards could offer at least as many or even more benefits for SMEs.

In the results of their research about the impact of environmental factors for IFRS choice in developing and

emerging countries, they note a positive impact for SMEs importance in that country. Governments better take the

sector into account and include positive things that IFRS for SMEs can deliver like the higher attraction of foreign

capital by enhanced transparency and higher comparability to understand the market and the position of the

countries’ enterprises better.

The second positive influence is the importance of foreign direct investments (FDI’s). When a country relies

excessively on foreign investments, IFRS can enforce SMEs, that usually suffer more to collect these fundings, to

reduce the cost of capital, provide better resource allocation as a result of the higher transparency and trust for

investors and debtors (Sellami & Gafsi, 2018). Kaya and Koch (2014) add that using this specific IFRS rule also

positively affects getting funds and loans from organizations like the World Bank and the IMF.

The final positive factor in Sellami and Gafsi (2018) is the degree of external openness from a certain country

toward the external world and the globalization of markets. With the increasing competition that follows, IFRS for

SMEs could help them promote more internationalization of their affairs and enhancing competitiveness for their

SMEs.

Strong tax system is a negative factor for the adoption because it requires higher switching costs by discarding

their own rule-based GAAP (referring to the different measurement and recognition criteria). The second negative

factor Sellami and Gafsi (2018) conclude is governance quality. Again, it causes higher switching costs because

these countries need retraining in the market, there are also more opportunity costs they usually already have a

strong national GAAP system better adapted to the local circumstances and finally they do not have equally high

pressure as countries with weaker governments to use IFRS for SMEs or in general (Sellami & Gafsi, 2018).

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The above-mentioned factors are in line with previous studies done on the subject of IFRS adoption mentioned in

the the paper from Sellam and Gafsi (2018). However, these factors were never investigated before in the case of

SMEs or developing and emerging countries specifically.

Finally, educational level and prior adaption of full IFRS do not have a significant positive impact on the adaptation

according to this research. Especially the latter can come across as a surprise because full IFRS would provide

countries with a lot of knowledge, organizational modifications, etc. to implement the new standard so they would

have less switching costs. This conclusion, going against the one of Kaya and Koch (2014), is important to my paper

because it suggests that the choice for IFRS and IFRS for SMEs is a completely separate matter (Sellami & Gafsi,

2018).

SMEs play an important role in economic growth of developing countries. The majority of GDP in these countries is

delivered by these SMEs (Sellami & Gafsi, 2018). That is why, in 2009, the IASB issued a specific standard for SMEs,

much easier to understand and adapted to their situation. Countries could use this standard instead of their own

GAAP, which could trigger earlier explained IFRS advantages like accounting quality, comparability and higher

capital inflow (mainly domestic investors for SMEs) (IFRS, 2018f). The biggest pitfall of the standard is that it is not

adapted to the local situation, while SMEs are even more country specific than other enterprises (Samujh & Devi,

2015). It is sure that, to benefit from this standard, countries first need to make modifications to adapt the

standard to the local situation. Partly due to the recent introduction and the lack of research, it is impossible to

make a clear decision yet about whether IFRS or the domestic GAAP is the best system for SMEs in developing

countries.

10 Domestic GAAP and differences with IFRS

As mentioned in Fino (s.d.) and Perera (1989), most local accounting systems in developing countries are not really

adapted to the specific local needs and economic situations.

Developing countries not using IFRS, mostly African countries, are usually working with small adaptations on

western accounting systems without having domestic relevance. Developed countries have other needs and

specifications and their accounting systems are shaped to facilitate these conditions. This causes big problems for

economic growth with issues of comparison, creating reliable budgets, measurement of a firm’s performance and

designing efficient domestic economic plans. The unreliable and insufficient accounting information causes

governmental bodies, investors and creditors to not rely on these numbers for decision-making. As a result, local

companies run the risk of losing potential resources and collaborations. This could form a huge burden in their

path to development. IFRS, adapted to the local situation can be a solution for this (Fino, s.d.; Perera, 1989). In this

section, I will discuss some cases of developing countries changing from their local GAAP to IFRS and the main

differences.

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Ding et al. (2007) discuss the general differences between the former IAS and 30 examined domestic GAAP in

2001. They blame the main differences between the systems mainly on institutional differences (legal system,

ownership and corporate governance, economic development, importance of accounting in the country and

importance of the trade market). Countries with higher concentration in ownership and weaker developed trade

markets have significantly more chance to lack in accounting rules from their domestic GAAP in comparison with

IFRS. On average, the higher the economic development, the higher the importance of accounting and the lower

the importance of the trade market, the higher the disparity between the domestic GAAP and IFRS in that country

will be. One of the most debated differences is the regular fair value use in IFRS, which is more representative

when the comparable markets and products are available, but this is not always the case and on top of that, the

calculation is much more difficult and time-consuming (Ball, 2006).

Next I am going to discuss some specific examples of developing countries.

First, Madawaki (2012) discusses the case for Nigeria, where they launched the official declaration for IFRS use in

2010. The most important public companies were required to implement IFRS since January 2012, other public

companies since the year thereafter and the SMEs have to implement the specific standard since January 2014.

The most striking matters that are absent in the local Nigerian GAAP compared to IFRS are equity changes, income

statement presentation and management estimates and reasoning. Other important differences between the two

systems are property, plant and equipment matters like fair value accounting, leasing, related parties, segment

reporting, impairments, risk management, employee benefits and the scope for consolidation (Madawaki, 2012).

An extensive overview of the differences can be found in appendix 2. The reasoning behind the switch is due to the

defects from the Nigerian GAAP and the expected benefits from IFRS mainly discussed before like accounting

quality, comparability, transparency, better investor decisions possible, attraction of FDI and other investments,

reduction of transaction costs across borders, reduction of total accounting costs for multinationals because of

same system use and so on. Nigeria still faces some major challenges in implementation like increasing awareness

for accountants and stakeholders, extensive training and staffing for professionals, auditors, users…, finding

resources for training and implementation (this is a big problem in Nigeria) and the lack of a big review of the tax

system and other laws. Madawaki (2012) argues that with good awareness and support, the switch can provide

some important benefits.

The next described case is about Brazil, based on Carvalho and Salotti (2013). Brazil is a developing country that

puts a lot of effort in the switch from Brazilian GAAP to IFRS. Note that there are still some important differences

with IFRS, such as five added standards. The decision to change was made between 2006 and 2007, and the

mandatory implementation for companies started from 2010 (optional starting from 2007). The standard is also

obligatory for SMEs. The Brazilian GAAP has its origin in a 1976 law and was based on the accounting system used

in the US at that moment. This system was strong for international practices and innovation, but had components

inhibiting necessary updates for new business challenges.

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This was because of the descriptive character; it was too detailed and included many mandatory practices. Before

2005, the local central bank and SEC were in charge of accounting regulations and implementations, with the lack

of an individual accounting standards-setting body (Carvalho & Salotti, 2013).

The change to IFRS was a logical step for Brazil because (1) the long tradition of high inflation and high losses in

purchasing power were solved and stable for a while, (2) the federal budget is stable and balanced and (3) the

Brazilian stock exchange became substantially more important with a GDP share of about 25%. For these reasons,

decision-makers and accounting professionals in Brazil were convinced to put effort in the further expansion and

internalization, which could be enforced by using IFRS (Carvalho & Salotti, 2013).

The biggest challenge was the transition from a rule-based approach to a principles-based approach. Most

countries shifting to IFRS had this same problem with their domestic GAAP being rule-based (Maines et al., 2003).

An example to explain the difference: for the valuation and depreciation in Property, Plant and Equipment,

consulting of a professional to determine the economic life is necessary for the principles-based approach, instead

of using fixed percentages and rules. Biggest issues concerning this shift are harder implementation and

enforcement (Maines et al., 2003). Another difference is for example the percentage-of-completion method used

in IFRS for real estate revenue. The final difference discussed by the authors is that only the old Brazilian GAAP

requires that equity accounting is included for certain investment decisions (Carvalho & Salotti, 2013).

The last country I am going to discuss is India. This is a bit of an exceptional case because India did not yet adopt

IFRS entirely, but the new Indian Accounting Standards (Ind AS) are strongly converged with IFRS (Jain, 2011). In

2007 India decided to switch Ind AS in phases starting in April 2012, but this has been delayed by the Indian

Ministry of Corporate Affairs (MCA). However, in 2015 the MCA launched a new schedule for Ind AS

implementation in steps.

First the biggest companies (with a net worth of more than 5 billion Indian Rupee (Rs.)) had to implement it

starting from April 1 2016. Second, companies with a net worth between Rs. 2,5 and 5 billion and all listed

companies below Rs. 5 billion had to prepare their balance sheet according to Ind AS since April 1 2017 and finally,

banking, insurance and other finance companies have a different road map starting from April 1 2019 (Deloitte,

2018; Jain, 2011).

The biggest differences between the old Indian GAAP and the new Ind AS/IFRS are similar to the differences

between IFRS and other domestic GAAP, as discussed above. First, the introduction of fair value accounting in

some standards and the principles-based approach causes volatility and subjectivity. The shift from the historical

cost approach is a major challenge. Second, the tax systems need to be shifted because the tax liabilities change.

Furthermore, Ind AS incorporates extensive guiding for both business combinations and financial instruments

while Indian GAAP is driven by legal forms (Agarwal, 2018; Deloitte, 2015; Jain, 2011).

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11 Conclusion

In my research on academic literature about the relationship between IFRS and development in developing

countries, some striking conclusions could be made.

First of all, most research shows that accounting is an important influence on development for developing

countries (e.g., ACCA, 2012; Boyns & Edwards, 1991; Hopper et al., 2017). Ignorance of the profession or bad

accounting quality could slow down the process of development (e.g., Hopper et al., 2017).

Furthermore, the IAS 41 standard about agriculture was discussed. This standard is essential for most developing

countries because the agriculture industry is believed to be a stepping stone towards development. While some

authors have opposing views (e.g., Matsuyama, 1992), most research concludes a positive relationship between

agricultural development and economic growth (e.g., Awokuse & Xie, 2015; Gollin et al., 2002; Johnston & Mellor,

1961). That is why the IAS 41 is that important to most developing countries and it should facilitate the further

development of the agricultural industry. However, the majority of literature argues that this standard currently

has too many issues to fulfill this purpose and using one of the other systems with some minor modifications might

be a better idea at the moment (e.g., Aryanto, 2011; Dowling & Godfrey, 2000; Elad, 2004). The identified

problems can be summarized as follows: issues with fair value calculations, big implementation barriers and costs,

no harmonization with other agriculture standards and usage difficulties (Aryanto, 2011.; Elad, 2004)

I explored the different factors that can affect a countries’ decision for implementing IFRS. Mainly based on two

leading papers, some conclusions can be drawn that can be used by policymakers in their decision of whether or

not adopting IFRS and by the IASB to determine their working points (Zeghal & Mhedhbi, 2006; Zehri & Chouaibi,

2013). Education level is significantly positive in both papers (Zeghal & Mhedhbi, 2006; Zehri & Chouaibi, 2013),

while existence of a financial market, Anglo-American background, rate of economic growth and common law legal

system are significant in only one of the two papers.

In the investigation of the advantages of IFRS for developing countries, improved accounting quality and higher

foreign funding flows are the most recurring elements. The accounting quality, mainly represented by things like

transparency, comparability and reliability, has a rather indirect effect on development, by causing higher

investors attraction, drive down cost of capital, provide better resource allocation and increase global resource

mobility (Ding et al., 2007; Soderstrom & Sun, 2008). Most researchers find a positive relationship between IFRS

use and accounting quality in both developed and developing countries (e.g., Ahmed et al., 2013; Barth et al.,

2006; Kim & Shi, 2012; Soderstrom & Sun, 2008) but they all argue that IFRS use on its own will not be enough to

make a significant impact. Accounting quality is also determined by legal and political systems, financial markets,

capital structure, ownership and the tax system. Many developing countries lag in these other factors, resulting in

the fact that they do not have a significant quality injection after switching to IFRS. Focusing on market

development and legal and political systems is very urgent because this influences a lot of factors facilitating

economic growth (Buntaine et al., 2017b; Ding et al., 2007; Soderstrom & Sun, 2008; Transparency International,

2018; Weingast, 2008). Authors who have some negative views about the improved quality assumption by IFRS use

in developing countries (e.g., Bova & Pereira, 2012) blame the lack of quality improvement on excessive disclosure

costs in comparison with the expected gains and low government follow-up causing low compliance and the fact

44

that the system is not adapted enough to the local situation. Another discussed reason for lack of quality increase

is that the quality of the older domestic GAAP could be better.

Increased FDI and market liquidity is another often cited advantage of IFRS. Most research finds a positive

significant relationship between higher FDI flows and development, although this is weaker for developing than for

developed countries (e.g., Hansen & Rand, 2006; Nair-Rechert & Weinhold, 2001; OECD, 2002). The authors are

convinced that FDI causes knowledge transfers, technology transfers and fill in resource deficits in developing

countries. By analyzing related literature, it can be expected that IFRS adoption will attract higher FDI flows for

developing countries (e.g., Chen et al., 2011; Daske et al., 2008; Gordon et al., 2012, Owusu et al., 2017). However,

just like it is the case for accounting quality, these effects are only really significant when facilitated by other

factors such as strong legal and political entities and financial markets.

Other possible benefits from IFRS for developing countries are better decision-making by companies (Persic et al.,

2013; Cohen & Karatzimas, 2013), providing an accounting regulation if they do not have (a good) one already

(Thompson, 2016) and attracting multinational companies (Tyrral et al., 2007).

IFRS also has potential downsides, besides problems combined with bad legal and political institutions.

Implementation and further compliance of IFRS causes a big cost raise, but most authors conclude that these costs

are not significant compared to the potential benefits, nor to the total revenue of most enterprises (De George et

al., 2013; Jermakowicz et al., 2017; Lasmin, 2012).

Another issue related to IFRS in developing countries is the lack of IFRS knowledge because of bad school systems

and the lack of experts (Tyrral et al., 2007). Problems concerning translation used to be a big issue for developing

countries, but this is mainly tackled due to efforts made by IFRS (IFRS, 2018e; Tyrall et al., 2007). Another big issue

concerns the fair value use instead of historical cost in some IFRS standards. Although this should present more

relevant economic information, this process often goes wrong in developing countries. This is due to uncertainties,

no comparable markets or products, manipulation by managers and so on (Ball, 2006).

However, when there is a good implementation and support, literature concludes that the benefits of

implementing IFRS in developing countries will outweigh the costs of it (Thompson, 2016).

Furthermore, the World Bank is a big influencer of development. Although some opposing views (e.g., Buntaine et

al., 2017a; Eiras, 2003), the World Bank and similar organizations could help developing countries in their

economic growth (The World Bank, 2017). They have a strong cooperation with the IASB and highly recommend

and support IFRS use for developing countries, which could help these countries to choose for the system. (The

World Bank, 2017; Van Greuning et al., 2011)

This paper also pays attention to the SME standard of IFRS, launched in July 2009. SMEs are an important part of

the GDP in a country and they are important for economic development. The standard aims to make disclosure

easier and better adapted to the situation for smaller companies (IFRS, 2018f). Similar benefits and costs like full

IFRS implementation are recognized, but because SMEs are more country specific, the standard is often not

enough adapted to the local situation (Kaya & Koch, 2014; Masca, 2012; Pacter, 2014; Samujh & Devi, 2015).

45

The general conclusion of this paper that can be drawn is that when IFRS is good implemented and supported by

well-developed legal and political systems and strong financial markets, it can play a key role in development in

developing countries. In that case, the benefits really seem to outweigh the costs. However, a lot of developing

countries struggle with poor working authorities and that is why it is hard to completely benefit from full IFRS.

Furthermore, the important IAS 41 agriculture standard and the SME standard turn out to have major

shortcomings, so especially for these matters the use of other systems might be recommended.

Note that IFRS is a relatively young system and the IASB is constantly updating the rules in order to raise quality.

More and newer research will be necessary to evaluate if the issues earlier raised in the literature are getting

smaller and if the benefits from IFRS turn out to have effects on the long-term. Finally, empirical research on this

particular subject is necessary.

VII

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Appendixes

Appendix 1 Developing countries according to the WESP report (United Nations, 2018a)

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Appendix 2 Overview differences between Nigerian GAAP and IFRS (Madawaki, 2012)