Convergence to IFRS, accounting quality, and the role of regional institutions: evidence from China

Abstract

Purpose The purpose of this paper is to examine the relationship between regional institution and accounting quality. Design/methodology/approach This study investigates whether and to what extent the convergence to International Financial Reporting Standards (IFRS) improves Chinese firms’ accounting quality. It also examines the role regional institutions play in this process. The focus is on two aspects of accounting quality: the accrual aggressiveness and the timely loss recognition. Specifically, the study tests: whether the convergence to IFRS significantly lowers the accrual aggressiveness proxied by the magnitude of discretionary accruals (DA); whether the convergence to IFRS significantly enhances the timely loss recognition proxied by the likelihood of reporting large negative net income; and whether the effects of convergence to IFRS on accounting quality vary with the quality of regional institutions. Findings The findings show that convergence to IFRS generally was accompanied by increases in DA and decreases in timely loss recognition for Chinese firms. Further analysis on the development of regional institutions reveals that both changes in accrual aggressiveness and timely loss recognition are more pronounced for firms located in regions with a lower level of development in the legal environment. Originality/value This study contributes to the accounting literature in several ways. First, it extends the accounting literature regarding institutional factors by examining the association between regional institutions and accounting quality. Second, by adopting a within-country setting, the study avoids such problems of cross-country comparisons as confounding factors caused by country-specific accounting rules and regulations, differences in infrastructure and culture, and other potential endogeneity problems (Chan et al., 2010). Third, the attention paid to the European and US application of IFRS overshadows the application and effects of IFRS in emerging markets. By examining China, the world largest emerging economy in the process of economic transition, this study sheds light on the effect of convergence to IFRS on accounting quality for emerging or transitional economies.