Analysis of Hidden Value and Value Relevance of Financial Statements Pre- and Post-IFRS Adoption

Abstract

This study analyses the hidden value and value relevance of financial statements pre-and post-IFRS (International Financial Reporting Standards) adoption. Prior studies on IFRS adoption provide conflicting evidence on value relevance. Market-to-book ratio and IFRS adoption value relevance using price is examined for Australian listed firms. Results show that IFRS adoption is value relevant over a longer period of time. Results are opposite for profit-making firms compared to loss-making firms which may explain the conflicting results. In the presence of goodwill, IFRS is not value relevant when post-global financial crisis (GFC) period is included. Market-to-book ratio has increased in the post-IFRS period lowering the usefulness of financial statements. Moreover, results show that macro-economic changes affecting valuation of firms may explain for differences in the results for market-to-book ratio and value relevance in different jurisdictions and time periods. Keywords: goodwill, hidden value, International Financial Reporting Standards (IFRS), impairment, value relevance IntroductionSeveral studies around the world have examined the benefits of International Financial Reporting Standards (IFRS) adoption. But the results from these studies provide conflicting evidence. This makes it difficult to draw definitive conclusions about the benefits of IFRS adoption. Different regimes have used varying approaches on goodwill recognition prior to IFRS adoption. Therefore, while IFRS adoption had a uniform impact on the way goodwill is reported and impaired, in the pre-IFRS regime, there are differences across jurisdictions that adopted IFRS.In Australia, a key difference in IFRS is the impairment of goodwill as opposed to systematic amortization as in previous years. This study tries to examine the reason behind the inconclusive results using goodwill and segregation of firms based on profitability as key accounting items. The value relevance of IFRS is analysed over a longer period of time. Moreover, the study examines the usefulness of financial statements pre-and post-IFRS adoption and explores whether the usefulness has increased or decreased over a longer period of time.Market-to-book ratio of the Standard & Poor's 500 over the past two decades rose from just over one in the early eighties to a peak of six by 2000, falling back to 4.5 by late (Beattie & Thomson, 2005. Such large changes in the difference between market value of equity and book value of equity suggest over the last 20 years that the usefulness of financial accounting has reduced significantly. Lev (2002) suggested that the difficulty of valuing firms that deal with concepts, rather than tangible assets and growing size makes an Mukesh Garg, Lecturer, Department of Accounting, Monash University. Email: mukesh.garg@monash.edu. economy more susceptible to Enron type collapses. Lev and Zarowin (1999) provided evidence which indicates that the usefulness of reported earnings, cash flows, and book (equity) values has been deteriorating over the past two...