The Role of Big4 in promoting IFRS

The audit of IFRS reports is one of the major services provided by the international accounting networks. This is because they possess necessary knowledge and skills, which could be used all over the world. However, there are negative moments in this process, which could be illustrated by conclusion made by Sucher and Alexander (2002) in their research:

     “Given their power over both the production and audit of IAS accounts, the Big Five firms play a very large role in interpreting and implementing IAS standards in a particular country.  This raises issues of power and responsibility with respect to compliance with IAS that need to be addressed clearly by the IASB”

So this post is going to address this issue and point out on existing problem especially in emerging markets.

Illustrations

The issue was substantially researched by Sucher and Alexander (2002) based on the example of Russia and by Sucher and Jindrichovska (2004) in study of situation in Czech Republic.

The problem is that companies in emerging economies suffer from lack of knowledge and expertise in preparation of IFRS accounts. The probable solution could be to hire IFRS specialist or to outsource reporting process. But on the one hand there is a shortage of qualified and experienced professionals in emerging markets. On the other hand, outsourcing by one and afterwards auditing by another independent firm are seen as superfluous costs. Finally, these companies opt into simple solution – they ask audit firms both to prepare and audit their IFRS accounts. This state of things as honourable auditors we can’t tolerate, can we?

Sucher and Alexander (2002) illustrated the situation by remark of one of Big Five (at the moment of research) interviewees:

“As you know we do not prepare accounts for our clients – it is an independence issue….however, we do provide a degree of assistance….. Some accountants in enterprises crunch the numbers (for IAS) and others say, ‘look guys we pay you to do it.  It is a fairy tale’”

It is not only willingness to save money, the issue is also related with the perception of an audit as no-value-adding activity. Interviewees in Czech Republic complained that the earlier Big 4 audit firm provided such package of services while the latest Big 4 auditors refuse to do this (Sucher and Jindrichovska 2004). One of the Big 4 auditors (interviewee) added fuel to the fire:

“Some financial managers and accountants [in enterprises] do not know what is going on [with IFRS]. They are only the passive receivers. In [X audit firm], there are templates that transform Czech accounting to IAS. The knowledge is kept in the audit company. It is big business [for the audit firm]. You can train companies to do the supporting sheets hut the final bit is done by the audit firm.”(Sucher and Jindrichovska 2004).

Meanwhile, management of the companies would always be keen on saving costs on such things like audit. It is quite likely that such kind of cosy relations are more beneficial to audit firms. At least they could have separated audit and accounting team, but according to research it would be too costly for audit firms and they end up by assigning one team of people to do both jobs, which is a shame.

Problems

The basic issue which arises here is how far should we trust financial statements prepared in emerging markets? To what extent this practice spread in other emerging countries, where corporate governance and law enforcement are not developed enough? I think that it is highly probable that similar “reporting-auditng” is practiced in China, where local management is rather pushy in accounting issues (see Deloitte’s case).

The other question how can we deal with the issue in sensible way. For example, one is audit manager and one is doing audit of IFRS reports of Brazilian company. The resourceful Brazilian finance director provides auditor with financial statements (FS) essentially based on Brazilian GAAP, but with name of IFRS on its face. The trick is that you will do honest auditing, spot discrepancies from real IFRS and provide list of adjustments which need to be done J It is foxy tactic, isn’t it?

What do you think about truthfulness of IFRS accounts of companies from emerging markets listed on global stock exchanges? Have you faced approach mentioned above in your reporting or auditing practice? How to discourage auditors from doing that especially in the context of coming “pure-audit-firms” legislation? Please share your knowledge and experience.

References

Sucher, P. and Alexander, D. (2002) IAS: Issues of Country, Sector and Audit Firm Compliance in Emerging Economies (London: Centre for Business Performance of the Institute of Chartered Accountants in England and Wales).

Sucher P., and Jindrichovska I. (2004) Implementing IFRS: A Case Study of the Czech Republic. EAA, Accounting in Europe, Vol. 1, pp. 109-141.

Auditors’ turn to needle Greece

Greece, Greece, Greece… all types of economists, political analysts, simply dilettantes, and  pseudo specialists are trying to comment on the issue of sovereign debt, Eurozone and the role of Greece in this mess. So I think it is time for us, accountants and auditors to make our pedantic and diligent (as we always do ;) contribution to process of pointing finger at Greece J

I have been recently interested in IFRS adoption in different countries and implications of this rather painful process. There are remarkable research papers dedicated to this topic, among which is study by Siqi Li (2010), who analyses impact of IFRS implementation on the cost of equity capital in Europe. I am going to use his analysis to raise some issues about Greece.

Lots of Requirements and No Enforcement

The author of research took into consideration the fact that effective implementation of IFRS depends on country’s institutional arrangements. In other words, benefits from mandatory IFRS adoption in terms of reduction in the cost of equity are expected to be sensitive to whether the new rules are effectively enforced (Li 2010). So, the scholar compared the European countries using such variables as law enforcement (utilizing studies by La Porta et al. (1998); Leuz et al. (2003)), additional disclosures and inconsistencies in standards. This interesting and appealing analysis was presented in Table 5 of his study, which is attached to this post.

Following observations could be made from this table.

First, the best “mutual friends”, Germany and Greece, are among top 4 countries, which had the greatest number of inconsistencies between local GAAP and IFRS. So here we see that Greece is not alone in it is remoteness from modern accounting practice. If you noticed, Spain is leader in terms of inconsistencies with IFRS.  

Second, considering the number of additional disclosures required per IFRS, Greece as well as Spain remain under our focus as leaders of the list. Germany occupied middle ranks. This shows that financial statements of the Greek and Spanish entities based on local GAAP were less transparent than the other European countries. Even newly accepted Poland and Czech Republic did better job in a convergence process.

Finally, according to the table the worst enforcement ratings belong to Greece, Italy, Spain, and Portugal. Does it remind you something? The problems with sovereign debt and liquidity touched exactly the same list of countries. I wonder if investment analysts use the enforcement ratings as factor to hedge investments of their clients, it would be good thing to do so.

But what can we infer from Greece’s ratings? Having the biggest number of inconsistencies and necessity of additional disclosures under IFRS the country faced huge challenge to enforce accurate financial reporting. On the other hand, low level of legal enforcement and development of institutions impeded this process.

This pattern of reasoning might leads us to the same conclusion regarding Greek tax system. As my Greek acquaintances evidence that the tax and legal system in Greece is overcomplicated and not easy to comply with. Thus, in the situation of low level of law enforcement, the efforts to evade taxes might be rather successful.  As a result this impacts tax collectibility and ability of country to meet its debt service obligations.

Quite another issue is the level of indebtedness of the Greek private businesses, particularly banks. Given the information above, can we rely on their IFRS financial statements and do they reflect actual financial position of businesses?

By the way

Kebab mix

By the way, I do not have anything against Greece or Greek people. In fact, last week I was in Greek restaurant and had fabulous dish of mixed kebab, which comprised of chicken, pork, and lamb meat as well as sheftalia… yummm, delicious! J

References

La Porta, R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny. 1998. Law and finance. The Journal of Political Economy 106 (6): 1113–1155.

Leuz, C., D. Nanda, and P. Wysocki. 2003. Earnings management and investor protection: An international comparison. Journal of Financial Economics 69 (3): 505–527.

Li, S. 2010. Does Mandatory Adoption of International Financial Reporting Standards in the European Union Reduce the Cost of Equity Capital. The Accounting Review 85 (2):  607-636

Nobes, C., ed. 2001. GAAP 2001: A Survey of National Accounting Rules Benchmarked Against International Accounting Standards by Andersen, BDO, Deloitte Touche Tohmatsu, Ernst & Young, Grant Thornton, KPMG, PricewaterhouseCoopers. New York, NY: J Wiley & Sons.