Accounting quality across different groups of firms under differential reporting framework: UK evidence

Abstract

Motivation: The IASB and the UK ASB have adopted different financial reporting rules for different classes of company. The IASB have IFRS and IFRS for SMEs. In the UK, currently companies follow IFRS (for public companies), UK GAAP (for medium-sized companies) or FRSSE (for small companies). Furthermore, some companies are exempt from audit. It is difficult to evaluate the efficacy of this approach to regulation since the ASB (and IASB) do not specify what consequences should follow. Do they expect public companies have higher accounting quality than medium and small companies? Or do they expect accounting quality to be the same across different groups of companies? Objective: The main objective of this study is to examine accounting quality in order to inform the future policy and discussion about the differential reporting framework. We examine the effects of accounting standards across public, medium and small companies. However, companies also face reporting discipline from market forces, and consequently we also examine the impact of debt-holders on reporting quality across and within medium and small companies. Methodology: We measure accounting quality from different aspects. For the assessment of differential accounting standards, we use: the level of accruals (ratio of cash flows to earnings), earnings smoothing, and target beating. For the assessment of any debt-holders effect, we use aspects that are suited to their needs, namely: earnings conservatism, and earnings persistence. Main Findings: Under the discipline of accounting standards, we find that the financial reporting behaviour of medium sized entities is significantly different from public and small companies. This suggests that accounting standards do not equalise accounting quality. The impacts of debt-holders on accounting quality are generally weak within medium and small companies. This implies that accounting standards are the main discipline for financial reporting for medium and small companies, which is consistent with the suggestions of Ball and Shivakumar (2005). However, we raise a few issues concerning the interpretation of the accounting quality measurements (earnings conservatism and earnings persistence) and provide theoretical and empirical support for the discussion. Recommendations: We suggest the accounting regulations for private companies may need to be further strengthened, especially for medium-sized companies.