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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. 784 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) 0.088 785 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. 787 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. References Accountants Today. (2005a) All aboard the FRS boat, December, 18(11) 20-23. 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