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Proceedings of Applied International Business Conference 2008
THE EFFECT OF COVERGENCE TO IFRS ON THE VALUE RELEVANCE OF
ACCOUNTING NUMBERS: THE CASE OF MALAYSIA AND SINGAPORE
Noraini Mohd Nasira,ψ, Muhd Kamil Ibrahima , Mustaffa Mohamed Zaina and Radiah Othmana
a
Universiti Teknologi MARA, Malaysia
___________________________________________________________________________________
Abstract
The movement for the convergence of accounting standards to the International Financial Reporting
Standards is driven partly by the globalization of the world’s market and partly by the need for a more
comparable and high quality financial reports. One of the advantages for convergence of accounting
standards is that it would lower the cost of processing information needed for investment purposes,
thereby increasing the efficiency with which the stock market incorporates the accounting information
in the stock price. When accounting information affects stock price, they are said to be value relevant.
This study aims to determine empirically the effect of the convergence of the local accounting
standards to IFRS on the value relevance of book value and earnings in Singapore and Malaysia. Data
on book values and equity were collected for 220 Malaysian Main Board companies over the years
2005 and 2006 and 144 Singaporean public listed companies for years 2004 and 2005 from Thompson
One Banker database. Using a multiple regression model, it was found that convergence to IFRS
seemed to have a significant impact on the value relevance of accounting numbers in Malaysia but the
impact is not significant in Singapore.
Keywords: Convergence of accounting standards; Value relevance; Book value of equity; Earnings.
JEL Classification Codes: M41.
1. Introduction
The need for high quality international accounting standards for financial reporting has been
accelerated by major scandals such as Enron, Adelphi communications and WorldCom. At the same
time globalization of the capital markets also requires a common financial reporting regime that would
greatly facilitate international investment. Realising these needs, the International Accounting
Standards Board (IASB) has spared no effort to promote the International Financial Reporting
Standards (IFRS) as the accounting standards that would fulfill these requirements. More than 100
countries have required or permitted the use of IFRS for their public listed companies (Deloitte,
Touche, Tomahmatsu, 2006)
The IASB is also encouraging countries all over the globe to converge their local standards to the IFRS
which would greatly reduce the complexities faced by the investment community in interpreting
financial reports prepared under different reporting standards. Convergence with IFRS is also expected
to facilitate the achievement of greater transparency of financial information among companies and
thereby help to lower costs for processing financial information (Accountants Today, 2005a). The
lower cost should lead to increase in efficiency with which the stock market incorporates it in prices
(Ball, 2006). Since the stock market also incorporates accounting numbers in equity prices,
convergence to IFRS is expected to have an effect on the value relevance of the accounting numbers.
ψ
Corresponding author. Noraini Mohd Nasir. Fakulti Perakaunan, Universiti Teknologi MARA,
40450
Shah
Alam,
Selangor
Darul
Ehsan.
Corresponding
author
E-mail:
[email protected]
Proceedings of Applied International Business Conference 2008
2. Convergence of accounting standards in Singapore and Malaysia
Convergence of accounting standards is not the verbatim adoption of the IFRS but “is the process of
narrowing down differences between the local or national accounting standards and the IFRS” (Ball,
2006, p9). This means that countries which undertake the convergence route will still retain their
national accounting standards but will modify them to be more aligned to the IFRS.
Singapore is one of the Asia Pacific countries that had set 2005 as the year of convergence to IFRS
(SGV & Co, 2004). The groundwork for convergence began in 2002 when it established the Council
of Corporate Disclosure and Governance (CCDG) to replace the Institute of Certified Public
Accountants of Singapore (ICPAS) as the accounting standard setter. The CCDG proceeded to issue a
set of Financial Reporting Standards (FRS) to replace the Singapore Accounting Standards issued by
ICPAS. Both sets of standards are closely aligned to the IAS (Delloitte &Touche [Singapore], 2003). In
2004, the CCDG adopted all the IASB projects including the improvement project resulting in a major
revision to its accounting standards for annual periods beginning on or after 1 January 2005 and more
new standards were issued in 2005 following the IFRS project (Delloite & Touche [Singapore], 2004)
With respect to Malaysia, convergence to international accounting standards became an important
national agenda because the government has always stressed that the level of transparency and good
governance within the corporate sector is crucial for the country’s long-term economic prospects.
According to Tan Sri Nor Mohamed Yakcop, the Second Finance Minister, the provision of clear,
transparent and credible financial reports would contribute to the nation’s growth as such reports would
enhance investors’ confidence in our markets (Nor, 2004). Hence, in line with the convergence
movement, the Malaysian Accounting Standards Board introduced 21 new and revised FRS in 2005
which are based on the IASB’s IFRS (Accountants Today, 2005a). These standards became effective
on 1 January 2006 (Accountants Today, 2005b).
Although the convergence to IFRS may marked a major shift in the local accounting practices, it was
perceived by many that the transition from national accounting standards to those based on the IFRS
would not be strenuous as the national standards have been based on the IASs (Lazar et al, 2006;
Deloitte & Touche [Singapore], 2004).
Value relevance of accounting numbers
Since the seminal work of Ball and Brown (1968), many studies have been done over the years to show
that accounting numbers are value relevant (e.g. Alford et al.,1993; Graham et al., 2000; and Ibrahim,
2005). Based on all these researches, it can be said that accounting numbers are value relevant when
they have an effect on stock prices. Their statistical association with stock prices reflects their
usefulness to investors (El Shamy & Kayed, 2005). Several studies have also shown that the value
relevance of these numbers are affected by accounting practices such as the use of accounting standards
(Graham & King, 2000; Black & White, 2003). Graham and King studied the value relevance of
accounting numbers in six Asian countries with different accounting practices and their results
suggested that differences in the value relevance of these numbers are related to the differences in
accounting practices across the countries. Their findings were supported by that of Black and White
who compared the income statement and balance sheet information between Germany, Japan and the
US. They found that the value relevance of earnings and book value of equity differs from one country
to another, partly due to the difference in their accounting practices.
There are also studies which show that, within a country, the value relevance of accounting numbers
differ when they are measured under domestic generally accepted accounting practices (GAAP) and the
IAS. For example, a study by Bartov et al. (2005) in Germany showed that the value relevance is
higher for earnings prepared under US GAAP or IAS than earnings prepared under German GAAP.
However, since convergence of accounting standards to IFRS is basically a new phenomenon, there are
very few studies to show the effect on value relevance of book value and earnings when countries
converge. Thus this study hopes to contribute to the literature by examining the effect of convergence
to IFRS on the value relevance of book value and earnings in Malaysia and Singapore.
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Proceedings of Applied International Business Conference 2008
3. Methodology and hypotheses
The purpose of this study is look at the effect on the value relevance of accounting numbers due to the
convergence of the accounting standards to IFRS in Malaysia and Singapore. Following previous
studies (e.g. Graham & King, 2000; Bartov et al., 2005, Ibrahim, 2005), book value of equity per share
and earnings per share are used in this study as proxies for accounting numbers. We then regressed
price on the book value of equity and earnings using the following models:
Pr iceit = α 0 + α 1 + α 2 BVS it + α 3 EPS it + ε it
(1)
(2)
Pr iceit = α 0 + α 1 I + α 2 BVS it + α 3 EPS it + α 4 I * BVS it + α 5 I * EPS it + ε it
where Priceit is the closing price per share of the security of company i at 30 June for year t+1; I is an
indicator variable equals to 1 for year when the standards were converged (zero otherwise); BVSit is the
book value of equity per share of company i at 31 December year t and EPSit is the earnings per share
of company i for the financial period ended 31 December year t. Price is taken six months after the
financial year end to ensure accounting information is available to the public (Lang et al., 2006; Barth
et al., 2008). Models 1 and 2 are based on the model used by Davis-Friday et al. (2006) in their
examination of the effect of the Asian crisis on the valuation of book value and earnings in Malaysia,
Korea, Thailand and Indonesia. Their overall findings supported research done by Graham and King
(2000) which showed that the relative value relevance of book value increases but the relative value
relevance of earnings decreases when the economic environments deteriorates. Thus a decrease in the
relative value relevance of book value and an increase in the relative value relevance of earnings would
indicate that the economic environment has improved.
Convergence to IFRS is purported to create a healthier economic environment for the country due to
the increased in transparency of financial reports and increased in investors’ confidence in the markets.
Hence, for this study, we predict that the relative value relevance of book value decreased but the
relative value relevance of earnings increased in the year when the convergence took place.
Hierarchical regression is used to determine the significance of the effect of convergence on the
accounting numbers
Sample
The study periods are years 2005 and 2006 for Malaysia and 2004 and 2005 for Singapore. The sample
consists of companies which have their financial year ending on 31 December. Banks and financial
institutions are excluded from the sample as they operate in a highly regulated industry and their
valuation parameters are likely to be different from companies in other industries (Graham & King,
2000). The book value of equity, earnings and price per share data were collected from Thompson One
Banker (Worldscope) database. After adjusting for outliers and incomplete data, there are a total of 440
observations for Malaysia and 288 observations for Singapore. Observations with the price value
exceeding four standard deviations from the mean were considered to be outliers and were removed
from the sample (Hair et al., 2006)
Table 1: Descriptive statistics
Variable
Panel A -Malaysia
(N = 220)
Year prior to convergence
2005
Year of convergence
2006
Paired
t-test
t ( p-value)
Effect size
Eta-squared
Mean
SD
Mean
SD
BVS
1.527
0.952
1.607
0.998
-5.701 (0.000)
0.13
EPS
0.098
0.182
0.125
0.167
-2.483 (0.014)
0.03
P
1.396
1.127
2.033
1.672
-10.657 (0.000)
0.34
Panel B- Singapore
2004
2005
(N =144)
BVS
0.546
0.738
0.606
0.894
-2.145 (0.034)
0.031
EPS
0.050
0.125
0.054
0.114
-0.427 (0.670)
0.001
P
0.719
0.895
0.828
1.043
-3.727 (0.000)
0.088
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Proceedings of Applied International Business Conference 2008
Table 1 shows the descriptive statistics of the book value of equity per share (BVS), earnings per share
(EPS) and price per share (P) of the companies over the two year period for both countries. From panel
A, it can be seen that in the year of convergence (2006), the Malaysian variables showed a statistically
significant increase in values. We calculated the eta-squared statistic to determine the magnitude of the
effect of the convergence on the values of the variables.
The effect can be considered to be large when the eta-squared = 0.14, moderate when eta-squared =
0.06 and small when eta-squared = 0.01 (Pallant, 2001). Our findings shows that there is a large effect
on price (eta-squared >0.14), a moderate effect on book value (0.06 < eta-squared <0.14) and only a
small effect on earnings (eta-squared = 0.01)
In Singapore (panel b), the book value of equity, earnings and price have also increased in values in the
year of convergence (2005). However, the eta-squared values showed that the convergence has only a
small effect on book value of equity and earnings (eta-squared <0.06 and 0.01, respectively) and a
moderate effect on price (0.06<eta-squared<0.14). Based on the descriptive statistics, we predict that
the effect of convergence of accounting standards to IFRS would be more significant in Malaysia than
in Singapore.
4. Findings
Table 2 presents the result of our regression models. Convergence of national accounting standards to
IFRS is purported to improve the economic environment by increasing the transparency and quality of
financial reports and the reduction of complexities of comparing information for investment decisions.
Any improvement in the economic environment would be reflected in a decrease of the value relevance
of book value and an increase in the value relevance of earnings. In our study, we therefore predict that
α4 would be negative and α5 would be positive. The result, as shown in Table 2, holds true for
convergence of accounting standards in both countries. In Malaysia, α4 is negative
(-0.034, t = 0.283) and α5 is positive (2.825, t = 4.169) indicating that the relative value relevance of book value has
decreased while the relative value relevance of earnings has increased (see Panel A, Model 2).
However, the decrease in the value relevance of book value is not significant (p > 0.05).
Table 2: Pooled regression of price on book value and earnings, controlling for the effect of
convergence to IFRS
α0
α1
α2
α3
α4
α5
Adj. R2
R2 Change
Panel A- Malaysia (N=440)
0.413
Model 1
Coefficient*
0.314
0.508
0.500
3.262
t-statistics
2.786
4.751
8.345
9.752
p-value
0.006
0.000
0.000
0.000
0.000
Model 2
Coefficient*
t-statistics
p-value
0.480
3.426
0.001
0.245
1.232
0.219
Panel B – Singapore (N=288)
Model 1
Coefficient*
0.209
0.056
t-statistics
3.970
0.832
p-value
0.000
0.406
Model 2
Coefficient*
0.235
0.008
t-statistics
3.969
0.099
p-value
0.000
0.921
*unstandardized coefficient
0.466
5.779
0.000
2.092
4.949
0.000
0.731
14.211
0.000
2.219
6.278
0.000
0.725
9.340
0.000
1.775
3.868
0.000
-0.034
-0.283
0.778
2.825
4.169
0.000
0.436
0.026
0.000
0.000
0.653
786
-0.017
-0.162
0.872
1.123
1.564
0.119
0.655
0.004
0.000
0.187
Proceedings of Applied International Business Conference 2008
Similarly, α4 for Singapore is negative (-0.017, t = -0.162) and α5 is positive (1.123, t = 1.564) (see
Panel B, Model 2). However, unlike in Malaysia where only the decrease in book value of equity is not
significant, here both the decrease in book value and the increase in value of earnings are not
significant (p>0.05). The R2 change values between Model 1 and Model 2 show that the impact of
convergence to IFRS is significant in Malaysia (p<0.05) but not significant in Singapore (p>0.05).
Table 3: Incidence of negative earnings and book value
Variable
Year prior to convergence
Year of convergence
Panel A –Malaysia (N = 220)
2005
2006
No of firms
%
No of firms
%
Negative BVS
1
0.5
0
0
Negative EPS
36
16.4
33
15.0
Panel B- Singapore (N =144)
Negative BVS
Negative EPS
2004
2
19
2005
2
24
1.4
13.2
1.4
16.7
In this study, companies which reported loss in earnings were not excluded from the sample. We
intended to test the effect of the negative values for book value of equity and earnings. However, due
the very low incidence of negative book value of equity (see Table 3), for further analysis we only
regressed price on negative earnings using the indicator NEGEPS equals one for earnings per share
with negative values (zero otherwise). This model is also based on the work of Davis-Friday et al.
(2006). We present our findings in Table 4.
It can be seen from the table that negative income does not have a significant effect on the value
relevance of earnings in both Malaysia and Singapore (p>0.05). The coefficient of earnings for both
countries are still positive and significant (Malaysia: β 2 = 6.082, t = 13.941; Singapore: β 2 = 8.088, t =
20.207). However, the coefficient of the interaction between negative earnings and earnings per share
for both countries are significant and negative (Malaysia: β 3 = -6.659, t = -6.408; Singapore: β 3 = 8.663, t = -11.503) indicating that earnings is less value relevant for companies reporting losses. This
finding is consistent with the findings of Davis-Friday et al. (2006) and Graham and King (2000). In
the earlier studies, negative earnings were shown to be less value relevant when the economy
deteriorates. In this study, it is shown that negative earnings is less value relevant even when the
economic environment seemed to have improved.
Table 4: Pooled regression of price on earnings, controlling for negative earnings.
Pr iceit = β 0 + β 1 NEGEPS it + β 2 EPS it + β 3 NEGEPS * EPS it + ε it
β0
β1
β2
β3
Malaysia
Coefficient*
t-statistics
p-value
0.935
10.248
0.000
-0.191
-0.925
0.355
6.082
13.941
0.000
-6.659
-6.408
0.000
Singapore
Coefficient*
t-statistics
p-value
0.254
5.169
0.000
0.034
0.293
0.770
8.088
20.207
0.000
-8.663
-11.503
0.000
(3)
Adj. R2
0.353
N
440
0.601
288
5. Conclusion
The results of this study show that the convergence to IFRS in Malaysia and Singapore seemed to have
improved the economic environment. In Malaysia, the convergence have moderately increased the
book value of equity but only marginally increased earnings. In Singapore, there seemed to be only a
small impact on the values of book value of equity and earnings. With respect to the value relevance of
the accounting numbers, the convergence to IFRS seemed to have decreased the value relevance of
book value of equity and increased the value relevance of earnings in both countries.
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Proceedings of Applied International Business Conference 2008
However, the effect is only significant on the value relevance of earnings in Malaysia. The
convergence does not seem to have a significant effect on the value relevance of earnings and book
value in Singapore. It has to be noted, however, that earnings is less value relevant for companies
incurring losses in both countries in spite of the improvement in the economic environment brought
about by the convergence. These findings lend support to the nations’ movement towards convergence
of accounting standards.
For future research, it may be worthwhile looking at the reasons why the effects of the convergence to
IFRS differ between Malaysia and Singapore. We also suggest that researchers look at the individual
standards to see how the differences in recognition and/or measurement between the IFRS and FRS, if
any, affect the valuation of the individual items.
Acknowledgement
The authors would like the acknowledge the following persons for their valuable assistance for this
paper – Dr Rashid Ameer and Ms Zuraidah Sanusi, Statistical Advisors, Faculty of Accountancy,
UiTM Malaysia, Mr. Ng Meng Kwai from Deloitte KassimChan, Ms. Ng Mi Li from
PriceWaterhouseCoopers and Ms Maizatul Azura Alias from Malaysian Institute of Accountants.
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