Readability of financial reports and IFRS adoption in Australia

This thesis examines the impact of the adoption of International Financial Reporting Standards (IFRS) on the readability of financial disclosures, firm performance and analysts’ forecasts in Australia. The thesis comprises three papers. The first paper (Chapter 2) provides an historical review of quality in relation to financial reporting in Australia by investigating how the qualitative characteristics of relevance, reliability, comparability and understandability developed in Australia between 1961 and 2004. The notion of the ‘quality of financial reporting’ has been debated extensively by accounting standard setters and regulators both nationally and internationally. However, there is no unanimous agreement as to the meaning of the word ‘quality’ or the qualitative characteristics that contribute to notions of ‘quality of financial reporting’. The objective of this paper is to investigate the meaning of quality in relation to financial reporting in different time periods over the past 40 years; how different characteristics were identified and developed; and how particular characteristics emerged, dominated and were then superseded or disappeared due to corporate collapses, changing economic conditions and globalisation. The second paper (Chapter 3) examines the association between readability, firm performance and IFRS in Australia by assessing the impact of the adoption of IFRS on the readability of Notes to the financial statements in the Australian context, and the interaction effect between IFRS and firm performance on readability. This paper uses the complexity of financial reports (Gunning Fog Index) and the number of words (Length) as proxies to measure the readability of financial reports. Results show that financial reports are significantly lengthier, yet are more readable in the post-IFRS period. Further, additional analyses identify that the length of disclosures in Summary of Significant Accounting Policies, Financial Instruments and Intangible Assets are significantly longer after the adoption of IFRS. However, there is no evidence to support any management obfuscation hypothesis in Australia as evidenced in prior United States (US) studies. Results do not demonstrate any differences in the readability of financial reports for poorly performing as opposed to better-performing firms in either pre- or post-IFRS periods, suggesting that managers continue to report both positive and negative information to investors. The third paper (Chapter 4) examines the association between the readability of financial disclosures, analysts’ forecasts and IFRS adoption in Australia by assessing whether the readability of Notes to the financial statements mediates the relationship between IFRS adoption and analysts’ forecast accuracy. Results indicate that the readability of firms’ disclosures mediates the relationship between IFRS adoption and the accuracy of analysts’ forecasts. That is, the paper partially explains that more readable financial disclosures after the implementation of IFRS lead to greater accuracy of analysts’ forecasts. As a whole, this thesis first explores the concept of the quality of financial reporting, where notions of quality can be traced under different names and elements. The thesis identifies that quality is captured by the four qualitative characteristics, relevance, reliability, comparability and understandability, where each qualitative characteristics represents an aspect of quality. The thesis then selects one of these aspects, understandability, and further narrows down to readability, in order to investigate the impact of IFRS on the readability of financial disclosures from: (1) the preparers’ perspective because management prepares financial disclosures in the form of Notes to the financial statements and they may implicitly make assumptions about the appropriate level of readability of financial disclosures; and (2) the users’ perspective because users read and attempt to understand the content of financial disclosures. In order to examine the preparers’ perspective, this thesis explores the relation between the readability of financial disclosures before and after IFRS adoption, and firm performance. To examine the users’ perspective, this thesis investigates the relation between readability, IFRS adoption and analysts’ forecasts.