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Isomorphism and resistance in implementing IFRS 10 and IFRS 12
Accepted Manuscript Isomorphism and resistance in implementing IFRS 10 and IFRS 12 Warren Maroun, Wayne van Zijl
PII:
S0890-8389(15)00036-0
DOI:
10.1016/j.bar.2015.07.003
Reference:
YBARE 706
To appear in:
The British Accounting Review
Received Date: 15 October 2014 Revised Date:
23 June 2015
Accepted Date: 16 July 2015
Please cite this article as: Maroun, W., van Zijl, W., Isomorphism and resistance in implementing IFRS 10 and IFRS 12, The British Accounting Review (2015), doi: 10.1016/j.bar.2015.07.003. This is a PDF file of an unedited manuscript that has been accepted for publication. As a service to our customers we are providing this early version of the manuscript. The manuscript will undergo copyediting, typesetting, and review of the resulting proof before it is published in its final form. Please note that during the production process errors may be discovered which could affect the content, and all legal disclaimers that apply to the journal pertain.
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Isomorphism and resistance in implementing IFRS 10 and IFRS 12
Author Details
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First author (corresponding author) Warren Maroun
Institution
University of the Witwatersrand, School of Accountancy
Address
1 Jan Smuts Avenue, Braamfontein Johannesburg
Email
[email protected]
Telephone
+27(0)11 717 8227
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Second author
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Author
Wayne van Zijl
Institution
University of the Witwatersrand, School of Accountancy
Address
1 Jan Smuts Avenue, Braamfontein Johannesburg
Email
[email protected]
Telephone
+27(0)11 717 8227
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Author
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Abstract The recently released International Financial Reporting Standards (IFRS) on consolidation accounting are
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used as a case study for demonstrating how coercive, normative and mimetic isomorphism are at work, driving a propensity to comply with the IFRS. At the same time the research explores how a ‘logic of resistance’ by preparers of financial statements influences how these standards are applied. The study finds that, far from being a neutral technical process, the functioning of accounting systems itself produces a dynamic for change and reform. Interviews describe a mutually reinforcing relationship
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between the introduction of new accounting requirements and the application of these requirements in complex social settings characterised by a ‘logic of resistance’. With no practical means of resolving this,
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the conflict between the International Accounting Standards Board (purportedly trying to improve financial statements) and users of the IFRS (in some instances seeking to apply the accounting standards to their own ends) is likely to be a defining feature of the next round of changes to the IFRS dealing with consolidation and the principle of control.
Key words:
Consolidations; International Financial Reporting Standards; Isomorphism, Logic of
Acknowledgements
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Resistance; Financial Reporting
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Thanks go to Professor Jill Solomon and Professor Robert Garnett for their comments on the dissertation and earlier versions of this paper. The authors would also like to acknowledge the participants of the
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Meditari Accountancy Research Conferences in Italy (2015) and South African (2014) and the Henley Business School’s GARI Conference (Henley on Thames). Finally, the authors are grateful to Mrs Lelys Maddock for editing the this paper and to the Sellschop Foundation for supporting part of the cost of this research project.
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Isomorphism and resistance in implementing IFRS 10 and IFRS 12
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Abstract The recently released International Financial Reporting Standards (IFRS) on consolidation accounting are used as a case study for demonstrating how coercive, normative and mimetic isomorphism are at work, driving a propensity to comply with the IFRS. At the same time the research explores how a ‘logic of resistance’ by preparers of financial statements influences how these standards are applied.
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The study finds that, far from being a neutral technical process, the functioning of accounting systems itself produces a dynamic for change and reform. Interviews describe a mutually reinforcing relationship between the introduction of new accounting requirements and the application of these requirements in complex social settings characterised by a ‘logic of resistance’. With no practical
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means of resolving this, the conflict between the International Accounting Standards Board (purportedly trying to improve financial statements) and users of the IFRS (in some instances seeking to apply the accounting standards to their own ends) is likely to be a defining feature of the next round
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of changes to the IFRS dealing with consolidation and the principle of control.
Key words: Consolidations; International Financial Reporting Standards; Isomorphism, Logic of
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Resistance; Financial Reporting
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1: Introduction1 Business failures and financial crises cause stakeholders to question the reliability of capital markets and demand remedial action from policy-makers (Zeff, 2003; Malsch and Gendron, 2011; Tremblay and Gendron, 2011). The development of accounting standards can be seen in a similar light with standard-setters frequently responding to corporate failures with the release of ‘improved’ financial
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reporting guidelines (Shaked and Sutton, 1981; Bengtsson, 2011). What is not, however, entirely clear are the processes at work which ensure compliance with new accounting standards or frustrate efforts at consistent application of accounting treatments. To this end, this research explores the possible application of the recently released IFRS 10: Consolidated Financial Statements (IFRS 10) and IFRS
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12: Interests in other Entities (IRS 12) by organisations as a type of case study.
We choose IFRS 10 and IFRS 12 because these accounting standards formalise consolidation accounting requirements and are widely applied in multiple jurisdictions where groups of companies
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are required to prepare consolidated financial statements. Unlike more specialised areas of accounting, such as insurance contracts or hedge accounting, IFRS 10 and IFRS 12 deal with accounting issues encountered by most large companies, irrespective of their specific sector. Nevertheless, consolidation accounting has not been studied in detail: most of the prior literature deals with the development of financial reporting standards in a social constructivist setting, concentrating on fair value accounting (Ravenscroft and Williams, 2009; Bengtsson, 2011; Durocher and Gendron,
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2014; Zhang and Andrew, 2014). This is despite the fact that IFRS 10 and IFRS 12 are among the most recent examples of standards released by the IASB in direct response to the global financial crisis, commencing in 2007, which accentuated the risk of divergence in consolidation accounting practice and off balance sheet vehicles undermining corporate transparency and accountability (IASB,
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2011a; IASB, 2011c; Hsu et al, 2012). Furthermore, because consolidation accounting discourse dates to the 1980’s, it offers a well-established and topical case for investigation (see International
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Accounting Standards Board [IASB], 2011a; IASB, 2011c; Nobes, 2014). More specifically, it provides an opportunity to illuminate how technical accounting standards are being interpreted and applied in a practical context, adding to the prior research which tends to focus on the development of discussion papers and exposure drafts by the IASB (see, for example, Gilfedder and Ó hÓgartaigh, 1998; Bengtsson, 2011) rather than on compliance with and resistance to accounting prescriptions in an operational setting (consider Hopwood, 2000).
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Non-standard abbreviations used include: IAS 27: Consolidated and Separate Financial Statements (IAS 27); IFRS 10: Consolidated Financial Statements (IFRS 10); IFRS 12: Interests in other Entities (IFRS 12); International Accounting Standards Board (IASB); International Financial Reporting Standards (IFRS); Integrated Reporting Committee of South Africa (IRC); Johannesburg Securities Exchange (JSE), SIC 12: Special Purpose Entities (SIC 12); South African Institute of Chartered Accountants (SAICA)
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ACCEPTED MANUSCRIPT In this context, and based on DiMaggio and Powell’s (2008) model of isomorphic behaviour, the objective of this research is to explore the normative, coercive and mimetic pressures to comply with IFRS 10 and IFRS 12. Contemporaneously, the research considers the nature and source of resistance to these accounting standards (see Cooper and Robson, 2006; Tremblay and Gendron, 2011). The choice of theoretical framing is in keeping with the prior research which points to the socially constructed nature of codes corporate governance and developments in their application (Tremblay
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and Gendron, 2011; Mennicken and Miller, 2012). It is also consistent with the relevance of discourse, isomorphism and resistance for explaining why global financial reporting standards have emerged (Rodrigues and Craig, 2007) and contextualising the ongoing debate on the measurement of elements of the financial statements at fair value or cost (Durocher and Gendron, 2014; Zhang and
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Andrew, 2014). Perhaps most important are the express concerns of regulators and the IASB that consolidation accounting requirements have been misapplied by preparers of financial statements to
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the detriment of transparency in financial reporting (IASB, 2011a)2.
Although the research is conducted in a single jurisdiction (South Africa), the study relies on the perspectives of financial reporting academics, auditors and preparers at multi-national organisations to provide a detailed account of the interpretation and application of IFRS 10 and IFRS 12. As such, the principles and themes emerging from the analysis are generally applicable for demonstrating the relevance of legitimacy and resistance for financial reporting practice (Durocher and Gendron, 2014). This adds to the calls for studies in the area of corporate governance which highlight the functioning
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of mechanisms of accountability and resistance in a real-world setting (Hopwood, 1987; Tremblay and Gendron, 2011). Concurrently, the research contributes to the need to explore how new regulations are interpreted and acted upon by the subjects of regulation (Cooper and Robson, 2006) to demonstrate how a drive for enhanced corporate transparency and accountability is tempered by a
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logic of resistance (consider Hopwood, 1987; Tremblay and Gendron, 2011; Waymire and Basu, 2011; Mennicken and Miller, 2012). . Finally, due to the recent release of IFRS 10 and IFRS 12, this
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paper is among the first to deal indirectly with the most current development in the area of consolidation accounting, providing a fresh perspective on this relatively technical and understudied accounting technique.
Before proceeding with the presentation of the theoretical framework and results, it is important to stipulate a number of limitations/delimitations. Firstly, and as touched on above, the research examines how IFRS 10 and IFRS 12 are being interpreted and applied by preparers, auditors and users 2
Nevertheless, it should be stressed that other theoretical frameworks could have applied, such as power and control and actor-network theories (as per Tremblay and Gendron, 2011). The aim is not, however, to consider every relevant theoretical perspective. Instead we follow the approach recommended by Tremblay and Gendron (2011) and Llewellyn (1996; 2003), using an institutional perspective to provide one account of the application of newly released IFRS’s. In other words, formal theory is used only as a frame of reference to inform and contextualise the analysis of the opinions of respondents, rather than form the primary basis of the research.
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ACCEPTED MANUSCRIPT of financial statements using the principles of isomorphism and a logic of resistance. The processes followed by the IASB when developing the accounting standards, including the relevance of lobbying by powerful constituents, are not within the scope of this research. In addition, a wide range of experts were interviewed to ensure that the results are detailed and balanced. In certain instances, differences in the experts’ opinions are pointed out. It is not, however, the express purpose of this research to deal specifically with the variations in the perceptions of different stakeholder groups. Finally, although
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the research is carried out in South Africa, the intention is not to concentrate on the relevance of South African idiosyncrasies for explaining how financial reporting standards are operationalised.
The remainder of this paper is organised as follows: section 2 provides a theoretical frame of reference and review of the prior literature. Section 3 summarises the IASB’s rationale for introducing
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IFRS 10 and IFRS 12. This is followed by an explanation of the chosen method in Section 4 and key
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findings in Section 5. Section 6 concludes and identifies areas for future research.
2: Prior literature and theoretical framework
Over time, laws and regulations designed to manage the divergent interests of agents and principals have become an integral part of modernity, contributing to the confidence of non-expert stakeholders
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in highly complex, institutionalised structures (Giddens, 1991; Unerman and O'Dwyer, 2004; Black, 2008). Less clear are the forces at work which contribute to compliance with or resistance to these new regulatory frameworks. In line with the view that periods of modernity are characterised by the functioning of powerful institutional forces (Giddens, 1990; Unerman and O'Dwyer, 2004), this research adapts Di Maggio and Powell’s (1983) model of isomorphic change to demonstrate why
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organisations would conform with new regulatory requirements. For this purpose, IFRS 10 and IFRS 12 are used as an example of recently released regulations which rely on coercive, normative
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and mimetic isomorphic pressures to condition the behaviour of preparers of financial statements. Following a similar approach to Tremblay and Gendron (2011), the research also highlights how a ‘logic of resistance’ is at work stimulating further change to the consolidation accounting space. As such, this research is inspired by the Hegelian dialectic described by Rodrigues and Craig (2007) in terms of which change in global reporting standards is a product of an accepted position (a thesis) being contradicted (antithesis) resulting in a period of conflict which reveals a different perspective on progression of accounting standards. This is based heavily on the view
that developments in
accounting are not just a technical process concerned with meeting the homogenous information needs of providers of capital (Hopwood, 2000; Mennicken and Miller, 2012) They are a product of the prevailing social and institutional context (Hopwood, 1987) and the need to secure legitimacy
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ACCEPTED MANUSCRIPT (Meyer and Rowan, 1977; Suchman, 1995). From this institutional perspective, coercive, normative and mimetic isomorphic pressures provide an important and widely used framework for describing how and why organisations conform to generally accepted accounting standards (Carruthers, 1995). This is juxtaposed with the relevance of resistance to the emergence of new prescriptions to reveal how accounting is shaped by the tensions between ‘thesis’ and ‘antithesis’ (Rodrigues and Craig,
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2007). 2.1: An institutional perspective on recent corporate reporting developments
Since the late 1960’s, institutional theories have suggested that many of the ‘dynamics in the organizational environment stem, not from technological or material imperatives, but from cultural
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norms, symbols, beliefs, and rituals’ (Suchman, 1995, p. 571). In this context, the existence of organisations cannot be attributed only to their ability to function as a rational, technical part of the
stakeholders (Meyer and Rowan, 1977).
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economic machinery. Organisations can only survive if they are regarded as legitimate in the eyes of
To this end, ‘legitimacy’ is the result of a normative assessment of the extent to which an organisation’s ‘means and ends appear to conform with social norms, values, and expectations’ (Ashforth and Gibbs, 1990, p. 177). In turn, this gives rise to powerful isomorphic pressures which explain how organisations develop or replicate policies, practices and structures, not necessarily out of practical necessity but in order to secure legitimacy (DiMaggio and Powell, 1983; Suchman, 1995).
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As such, ‘isomorphism’ – which has been co-opted from natural sciences to describe a process of homogenisation - is synonymous with ‘compliance’ and ‘convergence’ (Rodrigues and Craig, 2007). It can also be understood as a process of socialisation in terms of which aspects of everyday life are codified, formalised and institutionalised, ensuring their general acceptance and rendering alternate
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practices unimaginable (Meyer and Rowan, 1977). DiMaggio and Powell (1983) identify three ‘mechanisms’ of isomorphic change.
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Coercive isomorphism is a result of pressure exerted on organisations by their peers, including a drive to adhere to society’s expectations. For example, an entity may be under pressure to be seen as responsive to the concerns or interests of stakeholders in order to confirm that its business practices are aligned with societal expectations or value systems (Suchman, 1995). Coercive pressures may also be more explicit. For instance, an organisation may be required to operate in accordance with specific legal requirements or, more subtly, generally accepted practices which, over time, have been legitimated and institutionalised by powerful stakeholders (Meyer and Rowan, 1977; Suchman, 1995). By the same token, the codification of accepted practice and ‘enclosure’ of operating or reporting protocols can define acceptable corporate behaviour, making conduct to the contrary unthinkable and difficult to justify (Cowton and Dopson, 2002; Mennicken and Miller, 2012).
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ACCEPTED MANUSCRIPT Similarly, in the context of uncertainty, an organisation may seek credibility by replicating the actions, structures and symbolic displays of the most prominent or successful entities, a processes termed ‘mimetic isomorphism’ (DiMaggio and Powell, 1983). By conforming to prevailing heuristics, an entrant is able to achieve comprehensibility or be deemed legitimate simply by replicating the formal rational structures which have already attained a state of cognitive legitimacy (Suchman,
by formal systems of corporate governance serves as an example.
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1995). The proliferation of modern organisational structures (Meyer and Rowan, 1977) characterised
In a related manner, ‘organizations often pursue professionalization, thereby linking their
activities to external definitions of authority and competence’ (Suchman, 1995, p. 589). Claims to a repository of technical expertise or knowledge, for instance, can be a powerful source of (Hopwood, 2000; Power, 2003).
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credibility and a driver of normative isomorphic change
Analogously, an organisation may have its status enhanced if its senior managers are members of a
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professional body or are representatives on industry councils or expert panels (Abbott, 1981; DiMaggio and Powell, 1983; Suchman, 1995). Adherence to widely-known and respected codes of best practice, ethical standards and industry norms can have a similar effect, resulting in a change in how an organisation is operated or is presented to stakeholders (DiMaggio and Powell, 1983; King, 2012; Alleyne et al, 2013).
A key feature of coercive, mimetic and normative isomorphism is that they frequently function
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concurrently, influencing how organisations and institutions react to changes in their environments (DiMaggio and Powell, 1983).
This is evident when considering the development of financial
reporting frameworks (Hopwood, 1987; Rodrigues and Craig, 2007; Durocher and Gendron, 2014). Companies are expected to adhere to the prescriptions of global accounting standards, not only on the
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grounds of efficiency but also to confirm for stakeholders that these institutions are technically sound, modern, legally compliant and reputable (Carruthers, 1995). Isomorphic pressures can also
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have a socialising effect, influencing the behaviour and appearance of individual members of professional accounting firms (DiMaggio and Powell, 1983; Fogarty, 1992) and their propensity to accept the professional accounting standards as the only basis for describing a legitimate set of financial statements (Mennicken and Miller, 2012; Durocher and Gendron, 2014). Durocher and Gendron (2014), for example, explain how the underlying cognitive base of the fair value accounting paradigm has led to confidence in the direction taken by standard-setters and the automatic acceptance of fair value measurements by at least some professional accountants. Similarly, Rodrigues and Craig (2007) argue that: ‘Belief systems (such as belief in IFRS) gain momentum…as more people come to accept, as common knowledge, the particular views associated with that belief system and as ideas begin to crystallize about what is right, wrong, normal, and deviant’ (p. 744). 7
ACCEPTED MANUSCRIPT As explained by DiMaggio and Powell (1983) and Suchman (1995), the concurrent functioning of the rational logic of accounting standards, formal discourse and the technical knowledge base which informs the development of accounting standards ensures that everyday accounting practices are taken for granted and alternatives become unthinkable (Rodrigues and Craig, 2007). Normative pressures to adhere to IFRS are complemented by mimetic and coercive forces when one considers that the standards are being adopted in multiple jurisdictions, enjoy direct or indirect legal backing and
2010b; Johannesburg Securities Exchange, 2013). 2.2: A logic of resistance
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purport to ensure transparent and faithful financial reporting (see Rodrigues and Craig, 2007; IASB,
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Compliance with new regulations should not, however, be presumed. ‘The implementation of prescriptions is a dynamic and complex process, always subject to change and contestation’ (Tremblay and Gendron, 2011, p. 220). Processes of isomorphism suggest that an organisation will
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adhere to new laws and regulations3. Individuals, however, enjoy a considerable amount of discretion regarding how these prescriptions are interpreted and applied, meaning that total conformance cannot be guaranteed and unexpected results are common (Carruthers, 1995; Cooper and Robson, 2006).
Tremblay and Gendron (2011), for example, explore how prescriptions regarding the role and function of audit committees give rise to informal trials of strength. A logic of resistance means that
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new laws and regulations are not always complied with. Resistance may be grounded in individual assessments of the relevance of regulations which dispute their effectiveness or in efforts to describe previous failures as isolated in nature in order to preserve the status quo (see also Suchman, 1995). Alternately, resistance manifests itself in the ceremonial adoption of new laws and regulations
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resulting in underlying practices being modified superficially (see also Meyer and Rowan, 1977; Humphrey et al, 1992). In other instances, a legalistic mindset results where, although the rules are strictly adhered to, substantive change reflecting the intention or spirit of the regulations does not
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result (see also McMillan, 2004).
This suggests that, despite efforts to improve regulation of capital markets, complexity, the subjectivity involved in implementing new prescriptions and their unpredictable application by agents are inherent limitations on corporate governance systems to manage corporate conduct (Knights and Roberts, 1982; Bronson et al, 2011). A ‘gap’ between the interpretation of new corporate governance requirements by regulators and agents, including the practical issues encountered when applying these, can detract from the expected effects of recently enacted regulatory requirements (Vakkur et al, 2010; Tremblay and Gendron, 2011). Likewise, those charged with a company’s governance have 3
This would include recently released IFRS’s. Although IFRS are purportedly principles-based, they are treated as a formal prescription for the purpose of this research. The distinction between principles and rules in IFRS is deferred for future research.
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ACCEPTED MANUSCRIPT varied political and economic interests and are in a position either to accept or resist new mechanisms aimed at improving corporate transparency and accountability (see also Roberts and Scapens, 1985; Roberts et al, 2006). The result is that corporate governance systems have not remained static. They have been subject to a process of continuous revision as codes of best practice (and related legislation) react to and pre-empt financial crises and corporate scandals (West, 2006; Solomon, 2010; Tremblay
2.3: Amendments to IFRS: Isomorphism and resistance
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and Gendron, 2011).
What the preceding discussion highlights is the functioning of two opposing forces which can shed light on the development of the professional accounting space. Continuous improvement of the IFRS
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aims to enhance the relevance and reliability of financial reporting and the ability of users to make informed decisions about the stewardship of those entrusted with the management of organisations’ resources and obligations (Barth, 2008; IASB, 2009a; Ravenscroft and Williams, 2009). In this way,
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compliance with IFRS allows organisations to provide decision-useful information to investors and creditors, to mitigate agency costs and to provide a source of pragmatic legitimacy (Hopwood, 1987; Barth, 2008; IASB, 2010a). Adherence to the codified set of principles and rules is also a means of replicating financial reporting practices which are generally accepted, being applied in many jurisdictions by numerous organisations (Brown, 2011; IASB, 2012; Murphy et al, 2013). Furthermore, using IFRS is presumed to result in financial statements which achieve fair presentation,
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serving the general information needs of primary users of the financial statements (IASB, 2010a). The result is that compliance with international standards is an important source of organisational legitimacy.
The same logic applies to the recent release of IFRS 10 and IFRS 12. As discussed in more detail in
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Section 4, the standards formalise and enclose the consolidation accounting space providing a technical rational reporting discourse which preparers must adopt to achieve ‘fair presentation’ (see
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IASB, 2010a). Concurrently, the preparation of consolidated financial statements has been aligned with generally accepted best practice for communicating a particular economic position to users of the financial statements (see IASB, 2011a), making non-compliance difficult to justify. That IFRS 10 and IFRS 12 are introduced in the interest of corporate transparency and accountability reinforces the effect of isomorphic pressures on the regulated. This is especially true given that the standards are a direct response to global financial crisis and are deemed misapplications of consolidation accounting principles, as discussed in Section 3. We say ‘reinforce’ rather than ‘ensures’ because, as explained by Tremblay and Gendron, these accounting prescriptions are ‘interpreted and enacted by complex and oftentimes unpredictable human beings’ (2011, p. 260). Dynamic capital markets where preparers are required to interpret and apply accounting prescriptions can lead to a divergence between the intended application of new accounting 9
ACCEPTED MANUSCRIPT standards and their actual use. Added to this is the risk of legalistic application (McMillan, 2004), ‘self-preservationism’ (Roberts, 2009) and the inherent complexity of contemporary corporate environments leading to varied application of the IFRS’s (consider Cooper and Robson, 2006; Barnes, 2011; Karampinis and Hevas, 2011). In turn, the tension between isomorphic forces and a logic of resistance can shed light on how
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international accounting standards develop over time (Rodrigues and Craig, 2007), in particular, when it comes to IFRS 10 and IFRS 12. Section 3 discusses how the IASB has a history of responding to perceived misapplication of consolidation accounting principles (see Hsu et al, 2012). Adapting the model of thesis versus anti-thesis developed by Rodrigues and Craig (2007), coercive, normative and mimetic pressures can be seen as driving compliance with accounting prescriptions developed by the
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IASB (thesis). Nevertheless, a logic of resistance (anti-thesis) means that new regulations (such as those found in IFRS 10 and IFRS 12) are not automatically interpreted and applied as intended by the
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standard setter. Accordingly, the development of consolidation accounting can be interpreted as a synthesis of the effects of isomorphism and a prevailing logic of resistance (Rodrigues and Craig, 2007; Durocher and Gendron, 2014). Before discussing this in more detail, a brief history of the consolidation accounting is provided.
3: The introduction of IFRS 10 and IFRS 12
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IAS 27: Consolidated and Separate Financial Statements (IAS 27), originally issued in 1989, used a control-based model to identify subsidiaries4. It defined ‘control’ as the power to govern the operating and financial decisions of an entity so as to benefit from its activities, normally evidenced by a majority shareholding (IASB, 2008). To represent faithfully the economic reality of a parent having
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control over one or more subsidiaries, the financial position, performance and cash flows of the subsidiary companies needed to be consolidated with the parent’s, resulting in a set of ‘consolidated financial statements’5. These presented the activities of the group as a single economic unit (IASB,
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2008; IASB, 2009b). Due to the narow wording of IAS 27 it was, however, possible intentionally to avoid having to consoldiate an entity under one’s control. This was frequently achieved by ensuring that the parent had a limited shareholding in the subsidiary but was still able to govern the financial
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IAS 27 was issued in 1989 and was amended in 2003. At this time, the IASB did not reconsider the fundamental approach to consolidation of subsidiaries in IAS 27. In 2011, IAS 27 was superseded by IFRS 10 and IAS 27: Separate Financial Statements. 5
For the purpose of preparing a consolidated set of accounts, IAS 27 required certain ‘consolidation adjustments’ to be processed such as the elimination of intercompany balances and the parent’s investment in the subsidiary company against that company’s equity at acquisition. Further discussion of these principles is beyond the scope of this paper.
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ACCEPTED MANUSCRIPT and operating policies of the company other than by direct voting rights6. The limited direct equity interest by the parent, coupled with the difficulty of demonstrating how the parent derived direct economic benefits from the ‘special purpose entity’ (SPE) or ‘vehicle’ (SPV), resulted in circumvention of the requirements of IAS 27 (see IASB, 2011b; IASB, 2011a). In response, SIC 12: Special Purpose Entities (SIC 12) was issued during 1998 (IASB, 2010c). This
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interpretation sought to clarify and broaden the definition of ‘control’ per IAS 27, as a result, widening the consolidation net. Unlike IAS 27 it explicitly dealt with how, if a company was exposed to significant risks associated with the SPV and, in substance, enjoyed significant economic benefits from the relationship with the SPV, it should be consolidated. This would apply even if the parent did not hold the majority of the equity interest in the SPV (IASB, 2010c). The result, however, was that
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preparers interpreted SIC 12 as introducing an alternate model of control that could be interpreted independently of IAS 27. This allowed for a type of arbitrage between the two ‘models’ leading to financial statements7 (IASB, 2011b).
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certain entities remaining unconsolidated, to the detriment of the fair presentation of the respective
The global financial crisis commencing in 2007 made the lack of transparency regarding the application of consolidation principles more apparent, especially given the potential of off balance sheet vehicles to detract from the relevance and reliability of financial statements (IASB, 2011a, IN 5). As a result, the IASB added to its agenda a project on consolidation to address inconsistent
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application of consolidation principles, particularly ‘a perceived conflict of emphasis between IAS 27 and SIC 12’ (IASB, 2011a, IN3 – IN4, emphasis added). In May 2011, the IASB issued IFRS 10 and IFRS 12. The former details the revised definition of
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‘control’8 and consolidation principles (many of which were found in IAS 27 and SIC 12). The latter contains related disclosure provisions (IASB, 2011a; IASB, 2011b). With the release of IFRS 10, the IASB is of the opinion that it has provided additional clarity on the concept of ‘control’, reducing the
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potential for future varied application of consolidation principles (IASB, 2011a). IFRS 10 adopts a ‘step-by-step’ approach to determining control and is more broadly applicable than IAS 27. For 6
For example, an investor holding less than 50% of the voting rights in an investee may still have control over the latter due to contractual arrangements. These entities were often on ‘auto-pilot’ in the sense that their financial and operating policies could not be modified except by their creator or sponsor. These companies were often formed to carry out specific activities on behalf of their investors and were referred to as special purpose entities (SPE’s) or vehicles (SPV’s)
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Compounding this problem was the fact that IAS 27 and SIC 12 did not deal with a situation where an agent was used to manage the equity interests of a company. It was, therefore, possible for an intermediate (agent) to hold the majority of the equity in a company and appear to have control over that company while, in reality, control vested with the principal (PricewaterhouseCoopers, 2012). Consequently, such companies remained unconsolidated, despite the release of SIC 12 8
IFRS 10 defines ‘control’ as: exposure or rights to variable returns from involvement with an investee, where the investor has the ability to affect those returns by virtue of power over the investee (IASB, 2011a, para 6)
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ACCEPTED MANUSCRIPT example, unlike IAS 27 and SIC 12, it explicitly deals with agent-principal relationships. IFRS 10 explains how to identify principals and agents and determine whether or not an agent or principal has control over the investment in question. Like IAS 27 and SIC 12, it caters for situations where a company controls a subsidiary, despite holding less than 50% of the voting rights. IFRS 10 is, however, more explicit than SIC 12.
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It provides extensive guidance, with principles organised according to a defined hierarchy9, on how to assess whether or not voting rights confer control over an investee and on instances when voting rights do not clearly indicate whether the reporting entity ought to consolidate the prospective subsidiary. It also includes a number of anti-avoidance mechanisms not found in its predecessors, such as provisions for the consolidation of ‘ring-fenced’ assets (IASB, 2011a). The result is a highly
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detailed consolidation standard, complemented by an ‘application guidance’ and integrated examples that makes IFRS 10 considerably lenghtier than IAS 27 and SIC 12 and far less dependent on the
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application of professional judgement (PricewaterhouseCoopers, 2012; Danjou, 2013). Complementing IFRS 10 are the additional disclosure requirements introduced by IFRS 12. The IASB maintains that improved:
‘disclosure of a reporting entity’s interest in other entities [helps to] identify the profit or loss and cash flows available to the reporting entity and [to] determine the
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value of a current or future investment in the reporting entity’ (IASB, 2011c, IN 3). More specifically, there was a desire to increase disclosure regarding entities in which the investor had a ‘special relationship’, including ‘unconsolidated structured entities’10 (IASB, 2011c, IN 6 - IN 7). To this end, IFRS 12 effectively obliges preparers to disclose sufficient information to allow users
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to assess the nature of (and risks associated with) interests in those entities and the ultimate effect on the group’s financial statements (IASB, 2011c). Where a decision is taken not to consolidate a
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structured entity, IFRS 12 requires preparers to disclose the rationale for this. In addition, the nature, objective, size, and activities of the unconsolidated structured entity must be disclosed, including how it is financed and the reason for any financial support from the investor (IASB, 2011c). The result is that IFRS 12 essentially requires sufficient disclosure for users to assess the effect of not
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Firstly, the user is required to determine whether control is a result of shareholdings in the investee, in which case certain paragraphs of IFRS 10 are applied first. If the conclusion is that control is not evident or not a direct consequence of shareholdings, alternate paragraphs dealing with ‘structured entities’ must be applied. This is elaborated. For example, the indicators in paragraph B18 are considered only in circumstances where it is ‘difficult to determine whether an investor’s rights are sufficient to give it power over an investee’ (IASB, 2011a, para B18). Similarly, the guidance in paragraph B19 and B20 is to be applied sequentially only after paragraph B18 is considered. 10
An entity that has been designed so that the voting rights are not the dominant factor in deciding who controls it (IASB, 2011b, Appendix A).
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ACCEPTED MANUSCRIPT consolidating structured entities (IASB, 2011b; PricewaterhouseCoopers, 2012). The standard is, therefore, integral to the drive for enhanced corporate transparency at the heart of IFRS 10 (IASB, 2011c).
4: Method
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Due to the lack of direct prior research employing an institutional frame of reference for analysing IFRS, a qualitative approach was most suitable (see Brennan and Solomon, 2008; O'Dwyer et al, 2011). As discussed in Section 1, this research highlights how normative, coercive and mimetic isomorphic forces are at work driving compliance with IFRS 10 and IFRS 12. It also examines the presence and functioning of a logic of resistance necessitating an idiographic form of research where
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respondents can ‘interpret and describe the phenomenon in their own way’ (Holland, 2005, p. 250). The intention is not the generalisation of results in a positivist sense. Meaningful and detailed
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engagement with experts is needed to illuminate their perspectives on the application and development of consolidation accounting requirements (see O'Dwyer et al, 2011). This is consistent with the approach of comparable studies where the social construction of corporate governance and mechanisms of accountability are the focal point of the research (see, for example, Holland, 2005; Tremblay and Gendron, 2011).
Using detailed interviews allows the researcher to concentrate on the views of those directly involved
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with the preparation, audit or analysis of financial statements, including commentary from some of South Africa’s leading minds in auditing, financial reporting, financial analysis and corporate governance11. Relying on South African experts was driven by practical and substantive reasons. The authors are based in South Africa making access to interviewees in multiple jurisdictions cost
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ineffective. Despite this limitation, the focus on South Africa was considered appropriate. South African companies have been preparing financial statements using IFRS for several years. In addition, both company law and the JSE’s listing requirements mandate compliance with IFRS for listed
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companies, with the result that local preparers, regulators and academics have a detailed working knowledge of IFRS 10 and IFRS 12. The risk of over-emphasising the South African context was mitigated by the international relevance of the IFRS’s and the fact that many interviewees had international work experience, are based at multi-national organisations or are academics or regulators with detailed understanding of financial reporting developments in different jurisdictions. Furthermore, the researchers commenced each interview by describing the objective of the research and the fact that the study was intended for an 11
The researchers did not take into account the respective companies’ accounting/investment policies or technical accounting manuals/reports. These contained only generic information which did not add substantially to the analysis.
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ACCEPTED MANUSCRIPT international audience. Finally, the researchers relied on a fairly diverse group of interviewees. Although the sample of participants was driven to a large extent by ease of access and availability, the researchers focused on respondents who had a detailed practical understanding of consolidation accounting (Appendix B). The final sample of twenty three respondents included preparers from large listed companies who were involved in preparing consolidated financial statements, audit partners with experience on large group audits and analysts from the country’s investment houses (adapted
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from Holland, 1998a; Durocher and Gendron, 2014). To ensure a diverse range of opinions, each ‘class’ of respondent was equally represented12. It should, however, be reiterated (see Section 1) that this was to avoid the risk of response bias and not to evaluate in detail the nature of and reasons for differences in the perceptions of stakeholder groups.
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Potential interviewees were contacted either by telephone or by e-mail and invited to participate in the research. As a quality safeguard, they were informed of the nature and purpose of the research and
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guaranteed anonymity. A time was scheduled to meet with each interviewee and an outline of the research project, including a list of open-ended questions, was made available at least three working days before each interview. These questions addressed the possible operational effects of IFRS 10 and IFRS 12, including the rationale for introducing the new standards13. The questions centred around three main themes: whether or not the new standards achieved an added sense of corporate transparency and accountability; the extent to which the IFRS defines and codifies consolidation principles; and the possibility of the prescriptions of IFRS 10 and IFRS 12 being circumvented, as
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was the case with SIC 12. The questions were piloted during July 2012 with two academics at one of the country’s leading universities and two audit partners from one of the Big 4 audit firms in South Africa.
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Time was spent establishing rapport with the respondents who were encouraged to speak with complete candour; were reminded of their right to withdraw from the study at any stage; and were asked to agree to the recording of their interviews. Twenty-three interviews, each lasting between 45
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minutes and 3 hours were conducted in Johannesburg and Pretoria from October 2012 to May 2015. All interviews were semi-structured. On occasion, respondents were asked to explain a particular concept or statement in different words or from different perspectives to address ‘script coherent expressions’ or resolve any ambiguities (Alvesson, 2003). Although the sequence in which the issues
12
The fact that several respondents provided critical perspectives that challenged the status quo suggested that the interviews were not dominated by a single perspective.
13
IFRS 10 and IFRS 12 are only effective for annual periods commencing on or after 1 January 2013. While some respondents had encountered or dealt with the application of the new standards, others had not. In these instances, interviewees discussed the expected impact of the new standards. While this may be regarded as a threat to validity and reliability in a positivist sense, hypothetical reasoning is an accepted characteristic of interpretive studies (Llewellyn, 2003). In addition, due to the fact that interviewees have considerable experience with the IFRS, they were able to provide valuable opinions.
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ACCEPTED MANUSCRIPT were addressed – as well as the detail provided by each respondent – varied, the same themes were covered during each interview and the same point was used to commence each interview, namely: the requirement of IFRS 10 to prepare consolidated financial statements (adapted from Holland and Stoner, 1996; Holland and Doran, 1998; O'Dwyer et al, 2011). At no time did any of the interviewees express concerns about the nature of the study. Respondents’ motivation for participating in the study
these standards were or were not being applied in practice.
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appeared to come from their desire to discuss the technical aspects of IFRS 10 and IFRS 12 and how
In order to generate findings, the researchers analysed each transcript and made initial notes on the content. Theme categories (open codes) were used to group the contents of transcribed interviews.
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The ‘theme register’ included, inter alia, (1) technical analysis of IFRS 10 and IFRS 12, (2) the reasons for the introduction of the standards, (3) compliance pressures, (4) corporate transparency and accountability, (5) servicing information needs of stakeholders, (6) divergence in the application of
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IFRS 10 and IFRS 12 and (7) a logic of resistance.
This process was very detailed and time-consuming. It involved the researchers analysing each transcript and comparing and contrasting perceptions of respondents. In particular, emerging principles or themes pointing to the functioning of isomorphic pressures were identified. These were juxtaposed with arguments refuting the position that IFRS 10 and IFRS 12 are complied with. All
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notes were then numbered and cross-referenced to an open code register to allow for easy data analysis. Initial notes were contrasted and general data categories and interconnections were identified using a type of ‘data mind map’.. As part of this process, follow-up questions were raised if needed. The findings and substance of initial interpretations were not altered by the follow-up sessions
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(adapted from: Parker and Roffey, 1997; Leedy and Ormrod, 2001; Creswell, 2009; O'Dwyer et al, 2011; Rowley, 2012).
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To retain the study’s exploratory focus, the open codes were not predefined. Instead, they were interpretively developed by the researcher, based on the analysis of the prior literature (Section 2) and the initial review and contrast of interview transcripts. Naturally, this was an iterative and subjective process with coding of transcripts, cross referencing with the prior literature and refinement of the open codes occurring until a sense of saturation of the data was obtained. As part of this process, codes with few or no allocations were aggregated (adapted from Parker and Roffey, 1997; O'Dwyer et al, 2011; Maroun and Atkins, 2014). The final product was a ‘summary table’ for each transcript which effectively ‘assigned’ the transcript content to different content ‘pools’, each of which is aggregated under a finalised set of axial codes. These included codes for coercive, normative and mimetic isomorphic pressure and the nature of resistance to the application of IFRS 10 and IFRS 12.
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ACCEPTED MANUSCRIPT These codes were interpretively developed by the researchers to aggregate the main reasons for companies complying with, or resisting the prescriptions of, IFRS 10 and IFRS 12 according to the interviewees. The axial codes were refined based on discussions with participants at two international accounting conferences and informed the use of subheadings in the results section14. This did not detract from the exploratory nature of the study. Instead, it ensured a methodical analysis of the interview transcripts, allowing the main points being raised by interviewees to be analysed with a
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clear focus on the primary objective of this paper : exploring sources of isomorphic pressure which encourage compliance with IFRS 10 and IFRS 12 and the relevance of a logic of resistance (adapted from: Oakes et al, 1998; Holland, 1998a; Holland, 1998b; Leedy and Ormrod, 2001; Maroun and
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Atkins, 2014).
At this point, it should be stressed that the emphasis was on a broad examination of experts’ experiences and perceptions. Where a particular ‘class’ of respondents expressed a particular view on
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IFRS 10 and IFRS 12 this was noted and has been highlighted in the results section. It was, however, difficult to discern if there were significant divergences in the opinions of the different types of respondents. This is probably the result of the small sample size and related challenge of generalising results (Durocher and Gendron, 2014). It should also be pointed out that, due to the technical nature of the research subject matter, all of our respondents are professional accountants. As such, the inability to draw inferences on relevance of the identity or role of respondent for the functioning of isomorphic
5: Findings
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pressure and a logic of resistance should be interpreted with caution.
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5.1: Isomorphic pressures to comply with IFRS 10 and IFRS 12 Our interviewees identified various motives for complying with the requirements of IFRS 10 and IFRS 12. A systematic analysis of the interview findings, as discussed in Section 4, was used to
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identify key principles or themes which summarised the main reasons for adherence to the financial reporting prescriptions contained in the new standards. The findings are summarised below15. 5.1.1: Compliance with laws, regulations and stakeholders’ expectations: Coercive isomorphism The data highlights two primary coercive pressures to comply with IFRS 10 and IFRS 12: formal legal requirements and the informal operation of general cultural expectations 14
We would like to acknowledge one of the anonymous reviewers at an accounting conference who provided us with this most helpful recommendation. 15
Special thanks go to the conference participants at the International Corporate Governance Conference (2012) and GARI Conference (2012) for their assistance with the development of these codes. The authors would also like to thank one of the anonymous reviewers who recommended using the axial codes to provide more structure to the results.
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ACCEPTED MANUSCRIPT Legal requirements: Explicit isomorphic pressure Many interviewees cited legal requirements as the primary reason for compliance with IFRS 10 and IFRS 12. For example: ‘Why do we comply with IFRS 10? As I said, you can’t very well just ignore the explicit requirements of the IASB. But you also need to remember that the Companies Act makes
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it mandatory for us to use IFRS as our financial reporting framework. You’ve got to adhere to the country’s rules and regulations! If you don’t, you’ve acted contrary to the law! And that’s not going to fly.’ (R20)
Legal requirements represent a powerful institutionalised system which contemporary organisations
1995).
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must comply with to secure structural and procedural legitimacy (Meyer and Rowan, 1977; Suchman, When it comes to IFRS 10 and IFRS 12, for an organisation to be accepted as credible, it
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needs to be seen as acting in accordance with Company Law which requires financial statements prepared in compliance with IFRS16 (R20). Reinforcing this are the JSE’s requirement for listed companies to comply in all material respects with the international accounting standards in order to secure or maintain access to the local capital market (Johannesburg Securities Exchange, 2013). In addition, one respondent pointed out how,
‘You may find that we have particular contracts with important suppliers, customers or
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financiers which require us to disclose information about our group structure and transactions and balances in terms of IFRS 10. You have to comply with that if you want to do business with them’ (R10).
As explained by DiMaggio and Powell (1983, p. 151), the legal and technical requirements of
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powerful stakeholders ‘support the homogenisation of organisational models’. Coercive isomorphism can, however, function more subtly as evidenced by respondents’ interpretation of the relevance of
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revised consolidation accounting standards (Section 3) at a time when the South African capital market is becoming more aware of the importance of faithful and balanced corporate reporting (Atkins and Maroun, 2014).
Societal expectations as a subtle source of coercive isomorphic pressure: Over and above the legal requirement to comply with IFRS 10 and IFRS 12, coercive isomorphic pressures arise from the expectation ‘that organisations ought to be transparent’ (R9) and ‘consolidate those entities which they genuinely control’ (R22). With stakeholders’ confidence in the corporate
16
There may be instances where companies are able to use an alternate reporting framework. This is, however, beyond the scope of this research.
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ACCEPTED MANUSCRIPT reporting paradigm shaken by corporate scandals and financial crisis (R7; R12; R21), all preparers confirmed that there was an increased propensity to provide additional disclosure and ensure the consolidation of structured entities to conform to societal expectations. This went hand-in-hand with commitment to provide high quality consolidated financial statements ‘by ensuring that when you do, in substance, have control of a subsidiary…you include it in the consolidated financials’ (R15). In other words, there is a sense of pressure to meet stakeholders’ expectations for a complete set of
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consolidated results:
‘Look, it’s quite obvious that the emphasis is on transparency. You only have to read King [III] and the discussion papers on integrated reporting. People expect us to be more open in our reporting. Now, more than ever, you cannot afford to be in a situation where
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– after Enron and everything that’s been going on at the American banks – you are perceived as using the loopholes in SIC 12 and IAS 27 to avoid consolidating something.
produce high quality reports! (R20)’.
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I can tell you right now that that won’t fly. There is an expectation that you comply and
For many of the preparers and their auditors there is a sense of a fiduciary duty to stakeholders (cf DiMaggio and Powell, 1983). In particular, the proliferation of codes of corporate governance (Solomon, 2010) and the advent of integrated reporting (IOD, 2009) confirm stakeholders’ expectations for high quality, transparent corporate reports (see, for example, IOD, 2009; Solomon,
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2010; IIRC, 2011) with which respondents felt obligated to comply (R15; R22) ‘I really do think that you have to comply with IFRS 10. If you are really committed to the principles of good governance and you are committed to the users of your financials, you are not going to just disregard what the IASB tells you to do. Your major
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[stakeholders] just won’t tolerate that.’ (R22, emphasis added). Adherence to the disclosure prescriptions of IFRS 12 becomes part of demonstrating how the reporting
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entity is conforming with societal expectations for additional disclosure on SPV’s (consider IASB, 2011b) which encourages stakeholders’ confidence and confers credibility (R2; R6). For example:: ‘Taken together [IFRS 10 and IFRS 12] have opened up the company more than before. It’s more transparent and we will see this in terms of what kinds of disclosure you get…and this added transparency makes it easier to trust that company’(R7, emphasis added); According to Di Maggio and Powell (1983), organisations can be subject to subtle coercive pressures to conform to the structures and policies of those on whom they are dependent for support. What the above comments highlight is the importance placed on IFRS 12 disclosures by users and, accordingly,
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ACCEPTED MANUSCRIPT how compliance with the accounting standard becomes a means of signalling that the organisation is responding to the concerns of important constituents regarding the unconsolidated SPV’s (see Section 3). Collectively, the application of IFRS 10 and IFRS 12 are, therefore, about adherence to minimum reporting standards which ‘your large shareholders and other important users of financial statements are demanding’ (R22).
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To the extent that the financial statements are seen as non-compliant with IFRS 10 and IFRS 12: ‘[This]… tells you that they aren’t interested in being transparent and that their [corporate governance] is up to shit. You can’t work with those people. They either comply with [IFRS 10] or you can’t rely on their financials. You will probably sell out’ (R21).
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Summary
The above discussion highlights how stakeholder expectations for faithful and transparent corporate
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reporting complement the effect of Company Law and listing requirements mandating compliance with IFRS 10 and IFRS 12. As explained by DiMaggio and Powell (1983), these formal and informal pressures to adhere to reporting obligations and to meet societal expectations are a source of coercive isomorphism which, by promoting conformance to the dictates of influential stakeholders, become an
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important means of securing legitimacy (cf Suchman, 1995).
5.1.2: Compliance with technical rational reporting requirements: Normative isomorphism In addition to the effect of laws, regulation and societal expectations, the data analysis identified the
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importance of normative isomorphic pressures. The source of this include: (1) the technical detail of IFRS 10 and IFRS 12; (2) a sense of procedure and structure when applying consolidation accounting principles and (3) evidence of an epistemic commitment to the consolidation knowledgebase. Each of
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these is discussed below.
Technical rigour of IFRS 10 and IFRS 12 Respondents explained how the efforts of the IASB to define more precisely when one entity has control over another makes it difficult to bypass consolidation accounting. For example: ‘I think what they [are] trying to do with the implementation [guidance] is to give you rules for applying those principles [referring to the provisions in IFRS 10]. And I think what is going to happen is that as more and more schemes are
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ACCEPTED MANUSCRIPT uncovered, where they are trying to keep consolidations off17, I think they’ll just expand the [application guidance] to capture all of those things. That’s where I see things going’ (R7, emphasis added). By providing a more comprehensive basis for determining when one entity has control over another, auditors, preparers and analysts generally agreed that the result was the reduction of ambiguity in the
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accounting standards and this added pressure to comply. ‘IFRS 10 was about closing that loophole’ (R3). [The standard is] a response to non-consolidation of entities…where there was real risk exposure and the reader
could never discern it’ (R2). ‘[Ultimately], the IASB wanted more consolidations
probably going to get precisely that’ (R20).
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Procedures, rules and motifs of disciplinary power
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than IAS 27 seemed to provide’. (R1). ‘And with IFRS 10 and IFRS 12, it’s
Respondents noted that changing economic circumstances have contributed to the refinement of consolidation principles As explained by one expert
‘More transactions occur and these become more complicated. Maybe circumstances arise that you never thought of originally when [the standard
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setters] conceived the concept of subsidiaries and consolidations’ (R3). This technical perspective was, however, complemented by commentary which suggested that structure of IFRS 10 and IFRS 12 is a source of isomorphic pressure. On one level, this pressure is coercive in nature, especially if the requirements of the accounting standards are treated as a discourse
Miller, 2012).
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characterised by elements of disciplinary power (Foucault, 1977; Foucault, 1983; Mennicken and
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While a detailed analysis of Foucauldian theory of power and control is beyond the scope of this paper, it is interesting to note that many interviewees felt that IFRS 10 and IFRS 12 have allowed the concept of control and consolidation to be disaggregated into a step-by-step process (R9; R19). The actual consolidation exercise is no longer a technical professional one but is a series of functions or activities which are ‘segregated’, sequenced and disclosed (consider Hopper and Macintosh, 1993; Cowton and Dopson, 2002). This is highlighted by the following comment from a local preparer: ‘IFRS 10 follows a very systematic method. First, you have to look and see if you have power over the investee and the standard gives you two “decision trees” 17
In other words, trying to avoid the consolidation of an entity when doing so will be in their (preparers’) best interests.
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ACCEPTED MANUSCRIPT which you must work through, You must check to see if you have control because of voting rights, and if that is not the case, if you have a structured entity. In each case, the standard tells you exactly what to look for. Then you decide if you have exposure to variable returns and if you are acting as an agent or principal. At each stage, the standard refers you to the application guidance for step-by-step guidance’
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(R22). ‘Clearly spelled-out rules’ (R5) complement this by addressing past experiences of non-compliance and ‘enclosing’ the consolidation accounting space (R21). The result is that most of our interviewees felt that the added detail in the standards; use of extensive examples; a lengthy application guidance; and hierarchical process for identifying a parent-subsidiary relationship are designed to ‘condition you
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to think about consolidations in a particular way’ (R13) and encourage compliance with the ‘the increasingly rules-dependent approach in IFRS 10’ (R9). The effect is summarised by one expert:
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‘You will notice that IFRS 10 is much longer than SIC 12 and IAS 27. It often repeats itself and has a very long appendix that’s full of examples and specific rules...They [the IASB] probably wanted to drum the main points in our heads and show us specific cases where there have been problems in the past, to make sure that
Epistemic commitment
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preparers apply IFRS 10 as intended’ (R18)
A sense of commitment to the principles or cognitive base of consolidation was also evident (cf Durocher and Gendron, 2014). This does not depend on Foucault’s (1977) conceptualisation of
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disciplinary power but does take into account how technical accounting discourse and an underlying cognitive legitimacy are a source of normative isomorphic pressure (Smart, 2002; Rodrigues and
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Craig, 2007).
The formal structure of the accounting standards; a clearly defined consolidation process and the use of illustrative examples allow the prescriptions of IFRS 10 and IFRS 12 to constitute a generally accepted methodology (see Meyer and Rowan, 1977; Suchman, 1995; Power, 2003).
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contribute to a sense of technical rigour which is important for securing procedural and structural legitimacy (Suchman, 1995) With stakeholders unable to observe directly the financial reporting process, statements on compliance with the ‘sound practices’ (R6; R9) described by IFRS 10 and IFRS 12 secure legitimacy for the reporting entity by relying on generally accepted confidence in a clearly defined, well-developed, cognitive base (see DiMaggio and Powell, 1983).
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ACCEPTED MANUSCRIPT That the accounting standards are applied by multiple jurisdictions, have the backing of stock exchanges and enjoy the force of law, simply serves to emphasise the legitimising potential of compliance with the IFRS18 (R1; R7; R22). By then appealing to the need to respond to weaknesses in the prior definition of ‘control’ (R5); safeguarding against a lack of prior reporting transparency (R9); and serving the information needs of users of financial statements more efficiently (R17), the release of IFRS 10 and IFRS 12 has become integral to maintaining confidence in consolidation accounting
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practices. The result is the reinforcement of consolidation techniques as a taken-for-granted part of the accounting paradigm and, accordingly, something which preparers ought rationally to comply with to ensure their legitimacy in the eyes of stakeholders:
‘… the rationale behind IFRS 10 is that you have to consolidate what you control.
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It’s an activity-based standard. If you control something, you’ve got to show in your accounts that you’ve directed those activities. Anything else doesn’t make
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sense because it [consolidation] is a concept in our accounting standards. Why is this concept in our accounting standards? You don’t need to go that far. I don’t know exactly why, but that’s just the way it is. We comply with IFRS 10 because we must’ (R6, emphasis added).
IFRS 10 entrenches a generally accepted assumption that legitimate financial statements are those in which subsidiary companies are consolidated (R1; R10) resulting in adherence to consolidation
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accounting principles and techniques. Similar to the findings of Durocher and Gendron (2014), there is also a sense of confidence that the IASB understands the needs of users of financial statements and that the development of the new accounting standards as a means of improving corporate reporting (IASB, 2010) can be accepted as a statement of fact. To this end, it is conceivable that alternatives to
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consolidation are possible (R3; R18). The principle of control and consolidation has, however, become an inextricable part of day-to-day accounting practice to the extent that, for some respondents, a failure to consolidate an entity when it is under the control of another amounts to a
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failure to achieve fair presentation and, in essence, the failure to issue a legitimate set of financial statements (R7; R9; R20; R22): Summary
What interviews with prepares, auditors and investors
highlight is the existence of normative
pressures to adhere to the prescriptions of IFRS 10 and IFRS 12. With consolidation generally accepted as a rational and legitimate means of communicating a particular economic reality, a conformance strategy is a means of aligning the organisation’s financial reporting with accounting 18
Further discussion on the reasons for the globalization of IFRS, including the evolution of capitalist systems, is beyond the scope of this research. What is relevant for this paper is the fact that, as a global set of accounting standards, there is an incentive to demonstrate compliance with IFRS in order to secure legitimacy.
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ACCEPTED MANUSCRIPT principles which have, in essence, attained a state of cognitive legitimacy. Their taken-for-granted principles allow the new standards to ‘condition…your mind to think in [a certain way]’ (R1), effectively constituting the only discourse for describing ‘control’ and the accounting for the relationship between a parent and its subsidiaries (R9; R20). As explained by Suchman (1995) and Rodrigues and Craig (2007, p. 744), the normative isomorphic pressure of consolidation accounting ‘gains momentum (and hence power) as more people come to accept, as common knowledge, the
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particular views associated with that belief system’. IFRS 10 and IFRS 12 have codified a technical accounting practice. They are ‘accepted without question as the basis for preparing consolidated accounting under the law’ (R2). Added to this is the appearance of a technical rational procedure for consolidating two or more entities backed by due process, detailed research and extensive stakeholder
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engagement on the part of the IASB (R1; R3; R9). The result is that they represent the dominant discourse for describing this particular part of accounting practice and what constitutes a credible set of financial statements. Having attained at state of cognitive legitimacy (see Suchman, 1995),
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compliance with IFRS 10 and IFRS 12 becomes increasingly important for aligning the organisation with constituents’ belief sets and securing social standing (cf DiMaggio and Powell, 1983; Foucault, 1983; Rodrigues and Craig, 2007).
5.1.3: Cognitive legitimacy and the relevance of mimetic isomorphism With consolidation accounting attaining a state of cognitive legitimacy, it follows that adopting the
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requirements of IFRS 10 and IFRS 12 is important for signalling conformance with recommended best practice, avoiding criticism from stakeholders and either gaining or preserving legitimacy (DiMaggio and Powell, 1983; Carruthers, 1995).
One respondent, for example, explained the
decision to adopt IFRS 10 early as follows:
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‘The financial crisis showed us that companies…which had unconsolidated structured vehicles were being hammered for not being open about their group structures. Their
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reputations suffered because they didn’t consolidate and disclose their SPV’s to users. What we decided to do was show that we had nothing to hide. We early adopted so that our investors could see that we were not one of the companies which was using loopholes in SIC 12 and IAS 27 to manipulate the balance sheet and income statement’ (R22). As explained by DiMaggio and Powell (1983) and Suchman (1995), with previous practices subject to criticism, replicating the policies processes or outputs of successful organisations (which have, accordingly, avoided criticism) is a useful strategy for combatting threats to legitimacy. In the context of consolidation accounting, this amounts to rejecting the dual consolidation model under IAS 27 and SIC 12 – which has been associated with the 2007/2008 financial crisis (Section 3) – and signalling to
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ACCEPTED MANUSCRIPT users how the organisation has embraced the move towards more transparent reporting for structured vehicles. Equally relevant is the need for consistency with peers: ‘Comparability is a key issue when you look at early adopting IFRS 10. On the one hand, you need comparability for the reasons we all read about in the textbooks. You want users to be able to compare investments and ensure efficient allocation of capital. But
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there is also a lot of pressure to make sure that you don’t fall behind. If you are using IAS 27 [and SIC 12] but your major competitor is early adopting IFRS 10 and gives all the disclosure in IFRS 12 your investors are going to start wondering why you don’t do the same’ (R15).
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These comments highlight the concurrent functioning of normative and mimetic isomorphic pressures to comply with the new consolidation accounting standards. As discussed in Section 5.1.2, IFRS 10 and IFRS 12 constitute the generally accepted framework for describing the financial statements of a
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group of companies which achieve fair presentation. This has a powerful socialising effect which encourages compliance (see DiMaggio and Powell, 1983; Fogarty, 1992). By the same token, with the respective accounting and disclosure prescriptions taken for granted, preparing financial statements which are consistent with these standards and other leading organisations already complying with IFRS 10 and IFRS 12 becomes an important source of organisational legitimacy.
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5.2: On the logic of resistance
The above discussion should not be construed as suggesting that the new accounting standards are complied with in every instance. As explained by Rodrigues and Craig (2007), a given position or thesis is often challenged by counter-arguments, inconsistencies and contradictions (antitheses). In the
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context of IFRS 10 and IFRS 12, this is seen in the tension between the drive for compliance with the standards and the continuing relevance of a logic of resistance, the nature and sources of which are
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discussed in more detail below.
5.2.1: Failure to address self-interest and opportunistic behaviour Unlike the ongoing debate on the appropriateness of fair value versus cost accounting (for details in this regard see Ravenscroft and Williams, 2009; Durocher and Gendron, 2014), we find little evidence of respondents challenging the spirit of IFRS 10 or IFRS 12 on conceptual or ideological grounds. Instead, the primary source of resistance to the new accounting standards is rooted in the view that they are not an effective response to opportunistic behaviour undermining corporate transparency (cf Tremblay and Gendron, 2011). More specifically, several interviewees were not convinced that IFRS 10 and IFRS 12 would tackle effectively continuing ‘incentives to move things off balance sheet’ (R10). Consider, for example, the following comments:
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ACCEPTED MANUSCRIPT ‘What do you do with a loss-making subsidiary?...I have seen how companies will try to find ways to avoid consolidation because they didn’t want to report the failures to their investors and because their bonuses were performance-linked and their stock options were ready to be exercised. Of course, that’s not what they tell the public or their auditors. Instead, they use very complicated contracts to obscure the economics and
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confuse the auditors and make it seem like you don’t have to comply with IFRS 10” (R3) Classic agency problems undermine efforts to enhance the financial reporting system (see also Pesqueux, 2005; Malsch and Gendron, 2011). For several respondents (including both auditors and investors) IFRS 10 and IFRS12 do not do enough to mitigate completely the risk of capitalistic pressures on preparers to avoid consolidating structured vehicles when it is in their best interest do so.
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Related closely to this is the view that IFRS 10 and IFRS 12 ‘can’t make people more ethical’ (R9). Focusing on the technical features of consolidation accounting may reduce instances of
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misapplication of professional judgment but do not and cannot change the mindsets of those who have ‘commercialised finding ways to circumvent the requirements of IFRS 10 and IFRS 12’ (R22). In this context, many auditors and preparers were especially critical of the investment banking fraternity: ‘The [new standards] come up with a lot of extra information and give plenty of examples to make life more difficult for people who are already complying with IFRS and do nothing at all for the investment bankers of the world who were misapplying the
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accounting before IFRS 10; who are currently misapplying it to suit their interests; and will misapply the consolidation rules that the IASB come up with after the next crisis’. When asked if the negative views on investment bankers were only a result of the global financial
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crisis, one respondent stated:
‘That had a lot to do with the exceptionally complicated financial structures which the
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investment bankers (and their lawyers) used to do business…I think that a lot of this had to do with how they chose to consolidate or justify not consolidating some of the structures they were using to finance these deals. What has IFRS 10 and IFRS 12 done to stop this? Very little because all the IASB can do is come up with additional rules but those rules don’t take the money out of doing these deals and so the bankers’ own greed will continue to drive new ways to avoid consolidation’ (R22). As explained by Tremblay and Gendron (2011), resistance is mobilised by the belief that additional rules and regulations are not effective for tackling wayward agents, coupled with the position that non-compliance by at least some stakeholders is inevitable (p. 266). Respondents do not describe the technical details used to circumvent IFRS 10 and IFRS 12 but their views are important for showing
25
ACCEPTED MANUSCRIPT how negative sentiment weakens the link between improving consolidation accounting in the aftermath of the financial crisis (Section 3) and the operation of coercive, normative and mimetic isomorphism (Section 5.2). 5.2.2: Legalistic application of IFRS Initially, the preceding discussion can be interpreted as implying that resistance to IFRS 10 and
structuring transactions. This view can be dismissed:
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IFRS 12 is only hypothetical, possibly because their recent release has not allowed adequate time for
‘Only a few days ago, I got a call from [a colleague] who wanted to know how a deal could
be
structured
to
keep
an
SPV
off
of
the
books
under
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IFRS 10 because they were worried about the impact for [certain contractual guarantees].What was even more important was the attention from some of the investors
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and analysts. [The preparer] was very concerned about what IFRS 10 would do to the key ratios and the risk disclosures [required by IFRS 12 and IFRS 7]’ (R21). The researchers identified legalistic interpretation of the IFRS’s as a key mechanisms of resistance used to circumvent consolidating structured vehicles. One preparer, mindful of the pressure to ensure transparent reporting (Section 5.1.1), explains as follows:
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‘You obviously can’t turn around and say: “I am not going to consolidate this”. There are laws and contracts that you have to adhere to. Also, you will burn yourself with the investors and at the audit committee because these people put tremendous pressure on you to comply with IFRS. So you have to be smart and justify what you do in terms of
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the IFRS’ (R3, emphasis added).
Resistance does not take the form of overt departures from the standards. Instead, it is relying on the
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complexity of the standards and an interpretation of the rules and principles found in IFRS 10 and IFRS 12 to achieve a desired outcome: ‘What we are seeing is some of our clients analogising to the examples in IFRS 10. They take their transaction and then compare it line-by-line to the illustrative example which explains why you should consolidate….[They] start saying: But my scheme doesn’t fit exactly [into] example 14 so I don’t have to [follow that] example’s treatment…Bear in mind that the examples are part of the standard and are, therefore, authoritative. So, what some preparers are doing is saying “this example tells us what the IASB actually had in mind and how they want us to apply the relevant principles and because my transaction is not exactly the same that must mean that I don’t have to follow this example and consolidate” (R10). 26
ACCEPTED MANUSCRIPT ‘Don’t forget that IFRS is still based on principles and these can be difficult and subjective to apply…Very often, [clients] want to read the IFRS like a piece of legislation and ignore the principles or spirit of the IFRS. Some of the guys are looking at the rules in IFRS 10 and finding ways to interpret them differently to try and get a desired outcome and pay lip service to compliance with IFRS’ (R23).
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Most of the auditors interviewed by the researchers were not prepared to provide specific examples on the grounds of client confidentiality but one was willing to share an issue raised during a technical training session:
‘IFRS 10 refers to exposure to variable returns as an indicator that you have control over
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the investee. From the Basis of Conclusion we know that this is intended to mean an exposure to risk and rewards but there have been cases where the term is being interpreted very literally. My understanding is that a client created a synthetic instrument
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which includes a type of collar and they argue that the instrument pays returns linked to the company’s performance but that they are hedged on the fair value movements and are not exposed to variable returns. When you argue that the economics [are such] that they are exposed to residual risk and rewards and that the collar should be treated separately to give effect to the economics of the transaction, they come back with a very rigid (but correct) view that IFRS 10 does not refer to residual risk and reward or tell you to look at
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hedge they have created separately’.
As discussed in Section 5.2.2, the cognitive base underlying IFRS 10 – complemented by very detailed application guidance and extensive illustrative examples – is an important source of normative isomorphism which drives compliance. Paradoxically, this link between adherence to
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IFRS 10 and organisational legitimacy also means that overt demonstrations of defiance do little to impress stakeholders (R2; R3; R9). The result is that IFRS 10 and IFRS 12 are encouraging a
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legalistic application of the standards, contrary to the principles-based approach being advocated by the IASB. This allows some preparers to structure their results while maintaining that they conform with IFRS on technical grounds (R2; R14; R21): ‘I know of 3 or 4 cases where the client walked a very fine line but their arguments couldn’t be faulted because their particular case didn’t fit exactly with the paragraphs which we were relying on [in IFRS 10]. It came down to judgement. They argued their point and because of the technicalities and because we could not get consensus on whether what they had done was clearly wrong, we had to let it go’ (R6).
27
ACCEPTED MANUSCRIPT Despite the efforts of the IASB, IFRS 10 and IFRS 12 do not achieve a complete enclosure of the consolidation accounting space. The inherent complexity of transactions, and subjective application of IFRS by practitioners, means that it is simply impossible for the accounting standards to cater for every type of transaction which could give rise to a parent-subsidiary arrangement. As one expert summarised: ‘The transactions are complex and the standards are subjective. This leaves people with
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room to manoeuvre and structure transactions to achieve a specific outcome’ (R22). Almost all respondents were, however, critical of rules-based approach for addressing this problem arguing that this had done little to prevent financial scandals in the U.S.A. The consensus was that accounting standards have to provide principles which guide faithful presentation to ensure that they remain sufficiently flexible to cater for dynamic capital markets. As explained by two preparers, there
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are essential principles which can be applied to ensure that the underlying economics of innovative transactions are communicated faithfully to users of the financial statements (R1; R2). In this way,
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adoption of the requirements of IFRS 10 and IFRS 12 as part of a prudential reporting strategy is an important (and favourable) form of resistance to a rules-based accounting system. Nevertheless, the opportunity cost of principles-based standards is the risk of varied application of the guidance provided in IFRS 10 and IFRS 12 due to differences in professional opinion (R2; 7; R9) and the very real possibility of principles being manipulated when it is in the best interest of preparers to do so (R6; R22; R23).
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5.2.3: Denying relevance and rationalising non-compliance From a slightly different perspective, resistance is enabled by the ability to pay lip service to new prescriptions without the need for substantial reforms (Tremblay and Gendron, 2011). For example, a
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number of preparers pointed out that IFRS 10 and IFRS 12 had widened the consolidation net and had introduced potentially significant changes which, in their view, would have far-reaching implications for corporate reporting in their respective sectors. When, however, probed for examples specific to
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their organisations, the researchers were assured by several interviewees that new standards would have little direct effect. Evidence of pre-adoption impact assessments or detailed post-implementation reviews was not available.
Reflecting on the possibility of legalistic application of IFRS 10 and IFRS 12 (Section 5.2.2) and how companies were quick to dismiss the impact of the new standards on their business, one analyst felt that: ‘There is obviously no desire to “comply” in the true sense of the word. When these people say that [their transaction] did not fit exactly into this or that paragraph [of IFRS 10] or one of the examples but then say that they still comply with IFRS, what does that tell you? It tells me that it’s all about impression management. You say one thing to the 28
ACCEPTED MANUSCRIPT users but the reality is that you don’t really want to adhere to what the IFRS tells you to do if that doesn’t give you your desired outcome’ (R19). Respondents agreed that the legal and listing requirements to comply with IFRS 10 and IFRS 12 are sufficient to prevent preparers from overtly departing from the accounting standards (Section 5.1.1). Consequently, for the preparer seeking a particular accounting outcome which is inconsistent with the
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IFRS, the accounting standards must be adopted symbolically and kept separate from the actual accounting positon. As discussed in Section 5.2.2, legalistic application of the standards and reliance on professional judgement are used to circumvent consolidation accounting but maintain that the entity has (on strict reading of the standards) complied with the relevant prescriptions. As this approach becomes more common, it leads to a reflexive legitimisation of resistance strategies. This is
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explained by one respondent as follows:
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‘Once you have anything which preparers would like to avoid, you develop an industry around it. … The genesis of what actually happens in practice is [the company] would get the latest standards and then the merchant banks and financiers would go through that accounting standard and say: “Well, those are the accounting requirements where you have to account for [this transaction in a particular manner]. So we’ll just structure it…so it just falls out of those requirements... Because there was a rule that said [this
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accounting only applies if the holding is at] 90%. So, okay, we’ll make it 89%... If you want a result, there is a market for people who develop it for you. And, of course, even though you have this scheme, you can still tell the users that you comply in all material respects with the IFRS….This happened before [referring to IAS 27 and SIC 12] and it
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is probably going to be the same with IFRS 10 [and IFRS 12]’ (R2). This expert makes two important points. Firstly, to paraphrase Tremblay and Gendron (2011, p. 266), resistance is predicated on the view that ‘history will repeat itself’ and that regulation is ‘an
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ineffective means to solve challenging and enduring problems’ (see also Section 5.2.1). The alleged inevitability of this outcome (R2; R9; R22) does not condone explicit instances of non-compliance but it lessens their impact by suggesting deviations from IFRS are a logical (and possibly natural) part of the regulatory process (R9; R13). Secondly, there is an indication of the institutionalisation of mechanisms of resistance which are legitimised by a rational technical professional process dedicated to legalistic interpretation of accounting requirements. Expert: ‘I am not going to lie. As [a technical accounting expert], you do get calls from people asking you if they do X, Y and Z, will this allow them to avoid consolidating something. I had three of these calls just this year. They are looking for someone who they can say is an independent expert to sign-off on what they are doing’ (R3). 29
ACCEPTED MANUSCRIPT Researcher: ‘What are they doing?’ Expert: ‘Opinion shopping. They know that they have an SPV and they are looking for someone credible to confirm that what they are doing is in line with IFRS 10 or rather that what they are doing is not inconsistent with it’.
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Researcher: ‘Is this unusual? Expert: ‘No - As far as I know, there are some divisions in the investment banks and advisory departments that are making a living out of finding ways around IFRS 10. They use a lot of brainpower to come up with these deals which they then sign-off and who is going to have the
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time or inclination to challenge that?’
In other words, a logic of resistance relies on good faith assumption that because the technical experts have interpreted the provisions of IFRS 10 and IFRS 12, management’s position - even if contrary to
5.2.4: Corporate governance
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the spirit of sound financial reporting - is justifiable.
While legalistic application of IFRS, and associated impression management, was identified as the most relevant (and common) form of resistance, some respondents highlighted the importance of business ethics, corporate governance and the function of internal and external audit. For example,
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one expert made the following comment on the relationship between IFRS 10 and the external auditor: ‘The added detail in the IFRS’s provides auditors with a basis for demanding that a reporting entity consolidated its subsidiaries. But the opposite is also true. It’s also
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possible for the audit firms to rely on the detail in the standard and the complexity of the client’s transaction to justify not consolidating something if they feel that this is in the
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best interest of the business relationship with the client’ (R16). Form a different point of view, one preparer pointed out how the practical difficulties encountered by auditors when determining if the data being tested is completed can also allow SPV’s to go unconsolidated:
‘How would the auditor even know if the SPV is there? If you wanted to, you just don’t show them that contract. In the millions of transactions that happen every day, the chance that they pick up on it is, basically, zero. I mean, we have all been in a situation where the auditor doesn’t ask the question properly. You don’t want to correct them in front of everyone. That would be rude [laughs]’.
30
ACCEPTED MANUSCRIPT As argued by Power (1994; 2003) and Sikka (2009), the complexity of the audit process makes it almost impossible for users of the financial statements to verify the decision to refrain from consolidating a structured entity and the adequacy of the disclosures required by IFRS 12 in these instances. Conversely, the volume of transactions, intricacies of their client’s business models and inherent limitations of risk-based audit means that there is always a risk of non-compliance with
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accounting prescriptions going undetected. Other interviewees placed more emphasis on the role of the board of directors and audit committee. For these experts, IFRS 10 and IFRS 12 offer only a collection of principles and prescriptions. The regulation of their application vests with the governance structures of the reporting entity, in particular, the board and its committees. From this perspective, resistance to IFRS 10 and IFRS 12 are
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not the result of deficiencies in the standard but either weaknesses in or the inherent limitations of the controls put in place by those charged with the organisation’s governance. One preparer (and non-
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executive director) explains as follows:
‘In my experience, you have the biggest risk of unconsolidated structured entities when you have an inexperienced Board or Audit Committee. And the risk is a very real one, especially in some industries. If these guys have their finger on the pulse, they are going to ask the right questions and make sure that their finance teams are consolidating the SPV’s. Where things start to go wrong is when the oversight
governance’ (R1).
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functions fail. That’s got nothing to do with IFRS 10. It’s about bad corporate
It should be remembered that IFRS 10 and IFRS 12 are accounting standards and not substitutes for
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formal regulation. According to several interviewees, the country’s codes on corporate governance (IOD, 2009) and its Company Law (Companies Act, 2008), it is ultimately the responsibility of Boards of Directors and Audit Committees to ensure that financial statements
achieve fair
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presentation. IFRS 10 and IFRS 12 may not be able to address opportunistic behaviour by preparers (Section 5.2.1). At the same time, the principles found in these standards may be circumvented because of legalistic interpretation (Section 5.2.2) and the commercialisation of new means of avoiding the consolidation of SPV’s (Section 5.2.3). Where, however, significant resistance to IFRS 10 and IFRS 12 occurs this may have more to do with poor corporate governance than inherent limitations in the accounting standards. 5.3: The interconnection between isomorphism, legitimacy and resistance According to Rodrigues and Craig (2007, p. 741): ‘a thesis contains an incompleteness that gives rise to an antithesis…A synthesis overcomes the conflict by reconciling the truth contained in the thesis
31
ACCEPTED MANUSCRIPT and antithesis’. In the context of consolidation accounting, coercive, normative and mimetic pressures drive compliance with the new standards explaining why it was difficult to find examples of overt departures from IFRS 10 and IFRS 12. Enclosure of the accounting space is, however, left incomplete and compliance with the new accounting standards is tempered by a logic of resistance. In turn, the interaction between isomorphic pressures and resistance provides a revised thesis for explaining
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developments in accounting practice. This is explained by one respondent as follows:
‘Consolidations came about because of abuse. What do companies do [if they do not want to disclose negative information]? They choose to have special arrangements with their banks so that they can re-arrange their loans to appear on the books of another company
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and the end result is that the external debt of the group appears substantially reduced because it is put into a subsidiary that is not consolidated [because of technicalities]… This detracts from the usefulness of the financials because [they] do not reflect economic
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reality. So we introduce consolidations to better reflect economic substance’ (R11). As discussed in Section 3, however, the concept of ‘control’ per IAS 27 remains narrowly defined, necessitating the release of additional guidance. Although SIC 12 seeks to expand the ambit of consolidation principles (IASB, 2010c), a perceived tension between SIC 12 and IAS 27 has been exploited to exclude structured entities from consolidated financial statements when in the interest of preparers to do so (see Section 3). As these schemes are understood by users and standard setters, they
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are delegitimised and revisions to the IFRS follow to ensure consistent application of consolidation principles. The operationalization of this tension between isomorphic pressures (resulting in conformance with new accounting prescriptions) and logic of resistance is summarised by one
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respondent as follows:
‘We can say that there is a type of arms race between industry and standard setters. As soon as the standard setters find a loophole, they try to close it. And the industry then
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tries to find another loophole… As soon as you introduce the idea of consolidation and people don’t want to consolidate, they find reasons to justify that. IAS 27 requires people to consolidate, but some don’t and so the [standard setters] introduce SIC 12 to clarify what IAS 27 means. But some people still find a basis to avoid consolidation. SIC 12 ends up not being interpreted as the IASB intended and so IFRS 10 is introduced in response. I imagine that it won’t be long before people find creative ways of reading IFRS 10 and we find yet another interpretation being issued’ (R3).
Similar to the findings of Roberts (1985; 2009) what this comment demonstrates is the inherent limitations of mechanisms of accountability and transparency. Far from being a neutral technical process, the development of IFRS is, in part, a product of the continuous interaction between the 32
ACCEPTED MANUSCRIPT theoretical requirements of accounting standards and the actual application of these requirements in dynamic settings. In the context of a logic of resistance, the enclosing properties of IFRS 10 may, paradoxically, lead to new and innovative schemes for circumventing consolidation principles, necessitating a further round of revisions to the IFRS. This may be accentuated when, as discussed in Section 5.4.4, limitations in a company’s systems of governance and internal control leave the
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decision to keep SPV’s off of the balance sheet unchallenged.
6: Conclusion
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This paper adapts DiMaggio and Powell’s (1983) model of isomorphism to demonstrate how coercive, normative and mimetic pressures drive compliance with IFRS 10 and IFRS 12. Interviewees reported that the ‘enclosing style’ of the accounting standards – based on the use of application
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guidance, anti-abuse rules, and illustrative examples – is relevant for ensuring conformance to the revised consolidation principles. Being enacted to improve corporate transparency and accountability, and serve the interests of users, compliance with IFRS 10 and IFRS 12 is also an important means of demonstrating how an organisation’s financial reporting is in line with societal interests. The formal rational structure of the accounting standards; legal backing in some instances; and the taken-forgranted assumption that consolidated financial statements provide useful information to users, adds
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further isomorphic pressure and an incentive to comply with the new accounting prescriptions. The application of IFRS 10 and IFRS 12, however, also gives rise to resistance. Far from being a neutral technical process, the functioning of accounting systems itself produces a dynamic for change and reform as theorised by Hopwood (1987, p. 208).
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More specifically, changes to consolidation techniques are prompted by a misapplication of existing principles in IAS 27 and SIC 12. In particular, the interpretation of the standards to yield two
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different, and potentially conflicting, models of control have led to divergence in practice when determining whether or not an investor has control over its investees. In the context of the financial crisis commencing in 2007, the risk to users of financial statements as a result of unconsolidated structured entities distorting the financial position, performance and cash flows of the respective reporting entities is heightened, necessitating a refinement of consolidation principles. This culminates in the issue of IFRS 10 and IFRS 12 during 2011. These standards should not, however, be interpreted as a comprehensive means of driving improved financial reporting. Similar to the arguments of Cowton and Dopson (2002), Tremblay and Gendron (2011) and Brivot and Gendron (2011), we find examples of resistance to additional prescriptions imposed by the IASB. The complexity of the IFRS, the need for professional judgement, varied commercial contexts and the
33
ACCEPTED MANUSCRIPT underlying self-interests of agents imply that efforts at improving corporate transparency and accountability are tempered by certain preparers. This is made possible by the complexity of contemporary organisations and their consolidation environments, as well as inherent limitations in the corporate governance structures, allowing claims of compliance with IFRS 10 and IFRS 12 to be separated from their actual application.
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Overall, our interviews (irrespective of their areas of specialisation, their age, gender or ethnicity) describe a mutually reinforcing relationship between the introduction of new accounting requirements and the application of these requirements in highly complex social settings characterised by a ‘logic of resistance’. With no practical means of resolving this, the conflict between the IASB (purportedly trying to improve financial statements) and users of the IFRS (in some instances seeking to apply the
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accounting standards to their own ends) is likely to be a defining feature of the next round of changes to the IFRS dealing with consolidation and the principle of control.
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Rodrigues and Craig (2007) suggest that tensions between thesis (accounting as a rational economic system) and anti-thesis (the relevance of socio-political stimuli) shed light on the how global accounting standards may be developing in contemporary capital markets. These findings offer direct evidence in support of this concept of Hegelian dialectic for explaining the progression of financial reporting. They also address the need for context-specific research which sheds light on the operationalization of accounting standards and relevance of institutional theories for understanding
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corporate governance systems (Hopwood, 2000). Although the study only deals with specific IFRS’s, the principles and concepts highlighted by our respondents provide an interesting theoretical framework for illustrating how accounting standards are interpreted and acted upon by human beings. This is especially true given that the consolidation accounting standards are not necessarily more
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relevant for one industry than for another. On the contrary, consolidation principles are widely applied and provide an established case for investigation.
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Nevertheless, future research could expand on our work by applying a similar approach to other significant accounting developments. Most obvious is the proliferation of fair value accounting. While there has been a considerable amount of research examining the development of a fair value measurement basis (Durocher and Gendron, 2014; Zhang and Andrew, 2014) few have considered how resistance to fair value or cost accounting manifests itself in the ways in which preparers of financial statements are applying the relevant IFRS’s. In the same way, it would useful to consider the sources of isomorphic pressure which encourage the proliferation of fair value accounting and how fair value discourse becomes a source of legitimacy. Related to this is the need to understand better social characteristics which influence the relevance of isomorphism and the logic of resistance. With the social construction of accounting paradigms widely accepted (Hopwood, 2000; Rodrigues and Craig, 2007), it is necessary to consider how different 34
ACCEPTED MANUSCRIPT stakeholders interpret and react to the application of IFRS’s. Similarly, this study has not explicitly taken into account the relevance of South Africa’s cultural diversity for the interaction between isomorphic pressure and resistance for shaping changes to accounting standards. Researchers can, therefore, test our assertions by conducting a comparable study in other jurisdictions and considering whether key themes remain constant or vary. As Rodrigues and Craig (2007, p. 755) conclude: ‘It seems likely that more people will consider the process of isomorphism of financial reporting as
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important, while not forgetting the socially constructed nature of accounting and the need for it to adjust to social context’.
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Appendix A: Interview agenda
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The following questions were included in the agenda provided to respondents before the interview (Section 4). Additional probing questions were raised as needed. Although the sequence in which the issues were addressed (and the detail provided by each respondent) varied, the same themes were covered during each interview and the same point was used to commence each interview, namely, the requirement of IFRS 10 to prepare consolidated financial statements.
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1. What do you understand about the requirement to prepare a set of consolidated financial statements? 2. Why do you think the IASB introduced IFRS 10 and IFRS 12? What was the rationale behind introducing them? 3. Do you see any differences or discrepancies between IAS 27 and SIC 12? 4. Does IFRS 10 increase the scope of consolidation? 5. What do you think about the language used in IFRS 10? 6. Does IFRS 10 impact on the way in which you understand control and consolidation? 7. What are the principles contained in IFRS 10 and do you think there are any rules? 8. What do you think about the structure of IFRS 10 and IFRS 12? (This question was specifically for preparers and standard-setters) 9. Do you think that companies are going to comply with IFRS 10 and IFRS 12? What are the main reasons for compliance? 10. Do you think that it is possible for preparers to avoid the preparation of consolidated financial statements? What are the main reasons for this? 11. How relevant are the JSE’s listing requirements and the Companies Act (2008) for the application of IFRS 10 and IFRS 12. 12. What are the main reasons for complying with IFRS 10 and IFRS 12? 13. What do you think are the most common methods used to circumvent the requirements of IFRS 10 and IFRS 12?
35
ACCEPTED MANUSCRIPT
Appendix B: List of interviewees
19
Number
Length on
Cumulative
International
interview
years of
experience in
(approx.)
experience
respective
(approx.)
field
Preparer (multinational)
45 min
17
Yes
Respondent 2
Preparer (multinational)
30 min
17
Yes
Respondent 3
Preparer & academic
60 min
18
No
Respondent 4
Audit partner (assurance)
60 min
15
Yes
Respondent 5
Audit partner (technical)
45 min
16
Yes
Respondent 6
Audit partner (technical)
45 min
16
Yes
Respondent 7
Audit partner (assurance)
45 min
23
Yes
Respondent 8
Audit partner (assurance)
60 min
15
Yes
Respondent 9
Academic
60 min
12
Yes
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Respondent 1
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Background20
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Respondent
(financial
accounting) Respondent 10
Preparer (local company)
60 min
13
No
Respondent 11
Preparer
45 min
10
Yes
(former
audit
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manager) Respondent 12
Analyst (financial)
30 min
11
Yes
Respondent 13
Academic
120 min
15
Yes
45 min
18
Yes
(corporate
governance) Regulator
Respondent 15
Preparer (multinational)
60 min
17
Yes
Respondent 16
Retired investment banker
120 min
46
Yes
Respondent 17
Standard-setter
60 min
15
Yes
Respondent 18
Standard-setter
90 min
19
No
Respondent 19
Analyst
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Respondent 14
&
investor
120 min
22
Yes
&
investor
180 min
20
Yes
relations
Respondent 20
Analyst
relations
19
To protect interviewee identities, we did not link the interview excerpts mobilized in the text with the corresponding individuals in this table. 20
‘Preparers’ included financial directors, group financial accountants and senior financial accountants. All preparers are members of at least one professional accounting body.
36
ACCEPTED MANUSCRIPT Respondent
Background20
Number19
Length on
Cumulative
International
interview
years of
experience in
(approx.)
experience
respective
(approx.)
field
Investor
45 min
35
Yes
Respondent 22
Preparer (local company)
45 min
20
Yes
Respondent 23
Auditor
30 min
15
Yes
References
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Respondent 21
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PII:
S0890-8389(15)00036-0
DOI:
10.1016/j.bar.2015.07.003
Reference:
YBARE 706
To appear in:
The British Accounting Review
Received Date: 15 October 2014 Revised Date:
23 June 2015
Accepted Date: 16 July 2015
Please cite this article as: Maroun, W., van Zijl, W., Isomorphism and resistance in implementing IFRS 10 and IFRS 12, The British Accounting Review (2015), doi: 10.1016/j.bar.2015.07.003. This is a PDF file of an unedited manuscript that has been accepted for publication. As a service to our customers we are providing this early version of the manuscript. The manuscript will undergo copyediting, typesetting, and review of the resulting proof before it is published in its final form. Please note that during the production process errors may be discovered which could affect the content, and all legal disclaimers that apply to the journal pertain.
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Isomorphism and resistance in implementing IFRS 10 and IFRS 12
Author Details
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First author (corresponding author) Warren Maroun
Institution
University of the Witwatersrand, School of Accountancy
Address
1 Jan Smuts Avenue, Braamfontein Johannesburg
[email protected]
Telephone
+27(0)11 717 8227
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Second author
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Author
Wayne van Zijl
Institution
University of the Witwatersrand, School of Accountancy
Address
1 Jan Smuts Avenue, Braamfontein Johannesburg
[email protected]
Telephone
+27(0)11 717 8227
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Author
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Abstract The recently released International Financial Reporting Standards (IFRS) on consolidation accounting are
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used as a case study for demonstrating how coercive, normative and mimetic isomorphism are at work, driving a propensity to comply with the IFRS. At the same time the research explores how a ‘logic of resistance’ by preparers of financial statements influences how these standards are applied. The study finds that, far from being a neutral technical process, the functioning of accounting systems itself produces a dynamic for change and reform. Interviews describe a mutually reinforcing relationship
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between the introduction of new accounting requirements and the application of these requirements in complex social settings characterised by a ‘logic of resistance’. With no practical means of resolving this,
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the conflict between the International Accounting Standards Board (purportedly trying to improve financial statements) and users of the IFRS (in some instances seeking to apply the accounting standards to their own ends) is likely to be a defining feature of the next round of changes to the IFRS dealing with consolidation and the principle of control.
Key words:
Consolidations; International Financial Reporting Standards; Isomorphism, Logic of
Acknowledgements
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Resistance; Financial Reporting
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Thanks go to Professor Jill Solomon and Professor Robert Garnett for their comments on the dissertation and earlier versions of this paper. The authors would also like to acknowledge the participants of the
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Meditari Accountancy Research Conferences in Italy (2015) and South African (2014) and the Henley Business School’s GARI Conference (Henley on Thames). Finally, the authors are grateful to Mrs Lelys Maddock for editing the this paper and to the Sellschop Foundation for supporting part of the cost of this research project.
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Isomorphism and resistance in implementing IFRS 10 and IFRS 12
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Abstract The recently released International Financial Reporting Standards (IFRS) on consolidation accounting are used as a case study for demonstrating how coercive, normative and mimetic isomorphism are at work, driving a propensity to comply with the IFRS. At the same time the research explores how a ‘logic of resistance’ by preparers of financial statements influences how these standards are applied.
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The study finds that, far from being a neutral technical process, the functioning of accounting systems itself produces a dynamic for change and reform. Interviews describe a mutually reinforcing relationship between the introduction of new accounting requirements and the application of these requirements in complex social settings characterised by a ‘logic of resistance’. With no practical
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means of resolving this, the conflict between the International Accounting Standards Board (purportedly trying to improve financial statements) and users of the IFRS (in some instances seeking to apply the accounting standards to their own ends) is likely to be a defining feature of the next round
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of changes to the IFRS dealing with consolidation and the principle of control.
Key words: Consolidations; International Financial Reporting Standards; Isomorphism, Logic of
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Resistance; Financial Reporting
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1: Introduction1 Business failures and financial crises cause stakeholders to question the reliability of capital markets and demand remedial action from policy-makers (Zeff, 2003; Malsch and Gendron, 2011; Tremblay and Gendron, 2011). The development of accounting standards can be seen in a similar light with standard-setters frequently responding to corporate failures with the release of ‘improved’ financial
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reporting guidelines (Shaked and Sutton, 1981; Bengtsson, 2011). What is not, however, entirely clear are the processes at work which ensure compliance with new accounting standards or frustrate efforts at consistent application of accounting treatments. To this end, this research explores the possible application of the recently released IFRS 10: Consolidated Financial Statements (IFRS 10) and IFRS
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12: Interests in other Entities (IRS 12) by organisations as a type of case study.
We choose IFRS 10 and IFRS 12 because these accounting standards formalise consolidation accounting requirements and are widely applied in multiple jurisdictions where groups of companies
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are required to prepare consolidated financial statements. Unlike more specialised areas of accounting, such as insurance contracts or hedge accounting, IFRS 10 and IFRS 12 deal with accounting issues encountered by most large companies, irrespective of their specific sector. Nevertheless, consolidation accounting has not been studied in detail: most of the prior literature deals with the development of financial reporting standards in a social constructivist setting, concentrating on fair value accounting (Ravenscroft and Williams, 2009; Bengtsson, 2011; Durocher and Gendron,
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2014; Zhang and Andrew, 2014). This is despite the fact that IFRS 10 and IFRS 12 are among the most recent examples of standards released by the IASB in direct response to the global financial crisis, commencing in 2007, which accentuated the risk of divergence in consolidation accounting practice and off balance sheet vehicles undermining corporate transparency and accountability (IASB,
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2011a; IASB, 2011c; Hsu et al, 2012). Furthermore, because consolidation accounting discourse dates to the 1980’s, it offers a well-established and topical case for investigation (see International
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Accounting Standards Board [IASB], 2011a; IASB, 2011c; Nobes, 2014). More specifically, it provides an opportunity to illuminate how technical accounting standards are being interpreted and applied in a practical context, adding to the prior research which tends to focus on the development of discussion papers and exposure drafts by the IASB (see, for example, Gilfedder and Ó hÓgartaigh, 1998; Bengtsson, 2011) rather than on compliance with and resistance to accounting prescriptions in an operational setting (consider Hopwood, 2000).
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Non-standard abbreviations used include: IAS 27: Consolidated and Separate Financial Statements (IAS 27); IFRS 10: Consolidated Financial Statements (IFRS 10); IFRS 12: Interests in other Entities (IFRS 12); International Accounting Standards Board (IASB); International Financial Reporting Standards (IFRS); Integrated Reporting Committee of South Africa (IRC); Johannesburg Securities Exchange (JSE), SIC 12: Special Purpose Entities (SIC 12); South African Institute of Chartered Accountants (SAICA)
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ACCEPTED MANUSCRIPT In this context, and based on DiMaggio and Powell’s (2008) model of isomorphic behaviour, the objective of this research is to explore the normative, coercive and mimetic pressures to comply with IFRS 10 and IFRS 12. Contemporaneously, the research considers the nature and source of resistance to these accounting standards (see Cooper and Robson, 2006; Tremblay and Gendron, 2011). The choice of theoretical framing is in keeping with the prior research which points to the socially constructed nature of codes corporate governance and developments in their application (Tremblay
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and Gendron, 2011; Mennicken and Miller, 2012). It is also consistent with the relevance of discourse, isomorphism and resistance for explaining why global financial reporting standards have emerged (Rodrigues and Craig, 2007) and contextualising the ongoing debate on the measurement of elements of the financial statements at fair value or cost (Durocher and Gendron, 2014; Zhang and
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Andrew, 2014). Perhaps most important are the express concerns of regulators and the IASB that consolidation accounting requirements have been misapplied by preparers of financial statements to
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the detriment of transparency in financial reporting (IASB, 2011a)2.
Although the research is conducted in a single jurisdiction (South Africa), the study relies on the perspectives of financial reporting academics, auditors and preparers at multi-national organisations to provide a detailed account of the interpretation and application of IFRS 10 and IFRS 12. As such, the principles and themes emerging from the analysis are generally applicable for demonstrating the relevance of legitimacy and resistance for financial reporting practice (Durocher and Gendron, 2014). This adds to the calls for studies in the area of corporate governance which highlight the functioning
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of mechanisms of accountability and resistance in a real-world setting (Hopwood, 1987; Tremblay and Gendron, 2011). Concurrently, the research contributes to the need to explore how new regulations are interpreted and acted upon by the subjects of regulation (Cooper and Robson, 2006) to demonstrate how a drive for enhanced corporate transparency and accountability is tempered by a
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logic of resistance (consider Hopwood, 1987; Tremblay and Gendron, 2011; Waymire and Basu, 2011; Mennicken and Miller, 2012). . Finally, due to the recent release of IFRS 10 and IFRS 12, this
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paper is among the first to deal indirectly with the most current development in the area of consolidation accounting, providing a fresh perspective on this relatively technical and understudied accounting technique.
Before proceeding with the presentation of the theoretical framework and results, it is important to stipulate a number of limitations/delimitations. Firstly, and as touched on above, the research examines how IFRS 10 and IFRS 12 are being interpreted and applied by preparers, auditors and users 2
Nevertheless, it should be stressed that other theoretical frameworks could have applied, such as power and control and actor-network theories (as per Tremblay and Gendron, 2011). The aim is not, however, to consider every relevant theoretical perspective. Instead we follow the approach recommended by Tremblay and Gendron (2011) and Llewellyn (1996; 2003), using an institutional perspective to provide one account of the application of newly released IFRS’s. In other words, formal theory is used only as a frame of reference to inform and contextualise the analysis of the opinions of respondents, rather than form the primary basis of the research.
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ACCEPTED MANUSCRIPT of financial statements using the principles of isomorphism and a logic of resistance. The processes followed by the IASB when developing the accounting standards, including the relevance of lobbying by powerful constituents, are not within the scope of this research. In addition, a wide range of experts were interviewed to ensure that the results are detailed and balanced. In certain instances, differences in the experts’ opinions are pointed out. It is not, however, the express purpose of this research to deal specifically with the variations in the perceptions of different stakeholder groups. Finally, although
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the research is carried out in South Africa, the intention is not to concentrate on the relevance of South African idiosyncrasies for explaining how financial reporting standards are operationalised.
The remainder of this paper is organised as follows: section 2 provides a theoretical frame of reference and review of the prior literature. Section 3 summarises the IASB’s rationale for introducing
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IFRS 10 and IFRS 12. This is followed by an explanation of the chosen method in Section 4 and key
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findings in Section 5. Section 6 concludes and identifies areas for future research.
2: Prior literature and theoretical framework
Over time, laws and regulations designed to manage the divergent interests of agents and principals have become an integral part of modernity, contributing to the confidence of non-expert stakeholders
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in highly complex, institutionalised structures (Giddens, 1991; Unerman and O'Dwyer, 2004; Black, 2008). Less clear are the forces at work which contribute to compliance with or resistance to these new regulatory frameworks. In line with the view that periods of modernity are characterised by the functioning of powerful institutional forces (Giddens, 1990; Unerman and O'Dwyer, 2004), this research adapts Di Maggio and Powell’s (1983) model of isomorphic change to demonstrate why
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organisations would conform with new regulatory requirements. For this purpose, IFRS 10 and IFRS 12 are used as an example of recently released regulations which rely on coercive, normative
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and mimetic isomorphic pressures to condition the behaviour of preparers of financial statements. Following a similar approach to Tremblay and Gendron (2011), the research also highlights how a ‘logic of resistance’ is at work stimulating further change to the consolidation accounting space. As such, this research is inspired by the Hegelian dialectic described by Rodrigues and Craig (2007) in terms of which change in global reporting standards is a product of an accepted position (a thesis) being contradicted (antithesis) resulting in a period of conflict which reveals a different perspective on progression of accounting standards. This is based heavily on the view
that developments in
accounting are not just a technical process concerned with meeting the homogenous information needs of providers of capital (Hopwood, 2000; Mennicken and Miller, 2012) They are a product of the prevailing social and institutional context (Hopwood, 1987) and the need to secure legitimacy
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ACCEPTED MANUSCRIPT (Meyer and Rowan, 1977; Suchman, 1995). From this institutional perspective, coercive, normative and mimetic isomorphic pressures provide an important and widely used framework for describing how and why organisations conform to generally accepted accounting standards (Carruthers, 1995). This is juxtaposed with the relevance of resistance to the emergence of new prescriptions to reveal how accounting is shaped by the tensions between ‘thesis’ and ‘antithesis’ (Rodrigues and Craig,
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2007). 2.1: An institutional perspective on recent corporate reporting developments
Since the late 1960’s, institutional theories have suggested that many of the ‘dynamics in the organizational environment stem, not from technological or material imperatives, but from cultural
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norms, symbols, beliefs, and rituals’ (Suchman, 1995, p. 571). In this context, the existence of organisations cannot be attributed only to their ability to function as a rational, technical part of the
stakeholders (Meyer and Rowan, 1977).
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economic machinery. Organisations can only survive if they are regarded as legitimate in the eyes of
To this end, ‘legitimacy’ is the result of a normative assessment of the extent to which an organisation’s ‘means and ends appear to conform with social norms, values, and expectations’ (Ashforth and Gibbs, 1990, p. 177). In turn, this gives rise to powerful isomorphic pressures which explain how organisations develop or replicate policies, practices and structures, not necessarily out of practical necessity but in order to secure legitimacy (DiMaggio and Powell, 1983; Suchman, 1995).
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As such, ‘isomorphism’ – which has been co-opted from natural sciences to describe a process of homogenisation - is synonymous with ‘compliance’ and ‘convergence’ (Rodrigues and Craig, 2007). It can also be understood as a process of socialisation in terms of which aspects of everyday life are codified, formalised and institutionalised, ensuring their general acceptance and rendering alternate
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practices unimaginable (Meyer and Rowan, 1977). DiMaggio and Powell (1983) identify three ‘mechanisms’ of isomorphic change.
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Coercive isomorphism is a result of pressure exerted on organisations by their peers, including a drive to adhere to society’s expectations. For example, an entity may be under pressure to be seen as responsive to the concerns or interests of stakeholders in order to confirm that its business practices are aligned with societal expectations or value systems (Suchman, 1995). Coercive pressures may also be more explicit. For instance, an organisation may be required to operate in accordance with specific legal requirements or, more subtly, generally accepted practices which, over time, have been legitimated and institutionalised by powerful stakeholders (Meyer and Rowan, 1977; Suchman, 1995). By the same token, the codification of accepted practice and ‘enclosure’ of operating or reporting protocols can define acceptable corporate behaviour, making conduct to the contrary unthinkable and difficult to justify (Cowton and Dopson, 2002; Mennicken and Miller, 2012).
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ACCEPTED MANUSCRIPT Similarly, in the context of uncertainty, an organisation may seek credibility by replicating the actions, structures and symbolic displays of the most prominent or successful entities, a processes termed ‘mimetic isomorphism’ (DiMaggio and Powell, 1983). By conforming to prevailing heuristics, an entrant is able to achieve comprehensibility or be deemed legitimate simply by replicating the formal rational structures which have already attained a state of cognitive legitimacy (Suchman,
by formal systems of corporate governance serves as an example.
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1995). The proliferation of modern organisational structures (Meyer and Rowan, 1977) characterised
In a related manner, ‘organizations often pursue professionalization, thereby linking their
activities to external definitions of authority and competence’ (Suchman, 1995, p. 589). Claims to a repository of technical expertise or knowledge, for instance, can be a powerful source of (Hopwood, 2000; Power, 2003).
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credibility and a driver of normative isomorphic change
Analogously, an organisation may have its status enhanced if its senior managers are members of a
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professional body or are representatives on industry councils or expert panels (Abbott, 1981; DiMaggio and Powell, 1983; Suchman, 1995). Adherence to widely-known and respected codes of best practice, ethical standards and industry norms can have a similar effect, resulting in a change in how an organisation is operated or is presented to stakeholders (DiMaggio and Powell, 1983; King, 2012; Alleyne et al, 2013).
A key feature of coercive, mimetic and normative isomorphism is that they frequently function
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concurrently, influencing how organisations and institutions react to changes in their environments (DiMaggio and Powell, 1983).
This is evident when considering the development of financial
reporting frameworks (Hopwood, 1987; Rodrigues and Craig, 2007; Durocher and Gendron, 2014). Companies are expected to adhere to the prescriptions of global accounting standards, not only on the
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grounds of efficiency but also to confirm for stakeholders that these institutions are technically sound, modern, legally compliant and reputable (Carruthers, 1995). Isomorphic pressures can also
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have a socialising effect, influencing the behaviour and appearance of individual members of professional accounting firms (DiMaggio and Powell, 1983; Fogarty, 1992) and their propensity to accept the professional accounting standards as the only basis for describing a legitimate set of financial statements (Mennicken and Miller, 2012; Durocher and Gendron, 2014). Durocher and Gendron (2014), for example, explain how the underlying cognitive base of the fair value accounting paradigm has led to confidence in the direction taken by standard-setters and the automatic acceptance of fair value measurements by at least some professional accountants. Similarly, Rodrigues and Craig (2007) argue that: ‘Belief systems (such as belief in IFRS) gain momentum…as more people come to accept, as common knowledge, the particular views associated with that belief system and as ideas begin to crystallize about what is right, wrong, normal, and deviant’ (p. 744). 7
ACCEPTED MANUSCRIPT As explained by DiMaggio and Powell (1983) and Suchman (1995), the concurrent functioning of the rational logic of accounting standards, formal discourse and the technical knowledge base which informs the development of accounting standards ensures that everyday accounting practices are taken for granted and alternatives become unthinkable (Rodrigues and Craig, 2007). Normative pressures to adhere to IFRS are complemented by mimetic and coercive forces when one considers that the standards are being adopted in multiple jurisdictions, enjoy direct or indirect legal backing and
2010b; Johannesburg Securities Exchange, 2013). 2.2: A logic of resistance
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purport to ensure transparent and faithful financial reporting (see Rodrigues and Craig, 2007; IASB,
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Compliance with new regulations should not, however, be presumed. ‘The implementation of prescriptions is a dynamic and complex process, always subject to change and contestation’ (Tremblay and Gendron, 2011, p. 220). Processes of isomorphism suggest that an organisation will
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adhere to new laws and regulations3. Individuals, however, enjoy a considerable amount of discretion regarding how these prescriptions are interpreted and applied, meaning that total conformance cannot be guaranteed and unexpected results are common (Carruthers, 1995; Cooper and Robson, 2006).
Tremblay and Gendron (2011), for example, explore how prescriptions regarding the role and function of audit committees give rise to informal trials of strength. A logic of resistance means that
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new laws and regulations are not always complied with. Resistance may be grounded in individual assessments of the relevance of regulations which dispute their effectiveness or in efforts to describe previous failures as isolated in nature in order to preserve the status quo (see also Suchman, 1995). Alternately, resistance manifests itself in the ceremonial adoption of new laws and regulations
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resulting in underlying practices being modified superficially (see also Meyer and Rowan, 1977; Humphrey et al, 1992). In other instances, a legalistic mindset results where, although the rules are strictly adhered to, substantive change reflecting the intention or spirit of the regulations does not
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result (see also McMillan, 2004).
This suggests that, despite efforts to improve regulation of capital markets, complexity, the subjectivity involved in implementing new prescriptions and their unpredictable application by agents are inherent limitations on corporate governance systems to manage corporate conduct (Knights and Roberts, 1982; Bronson et al, 2011). A ‘gap’ between the interpretation of new corporate governance requirements by regulators and agents, including the practical issues encountered when applying these, can detract from the expected effects of recently enacted regulatory requirements (Vakkur et al, 2010; Tremblay and Gendron, 2011). Likewise, those charged with a company’s governance have 3
This would include recently released IFRS’s. Although IFRS are purportedly principles-based, they are treated as a formal prescription for the purpose of this research. The distinction between principles and rules in IFRS is deferred for future research.
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ACCEPTED MANUSCRIPT varied political and economic interests and are in a position either to accept or resist new mechanisms aimed at improving corporate transparency and accountability (see also Roberts and Scapens, 1985; Roberts et al, 2006). The result is that corporate governance systems have not remained static. They have been subject to a process of continuous revision as codes of best practice (and related legislation) react to and pre-empt financial crises and corporate scandals (West, 2006; Solomon, 2010; Tremblay
2.3: Amendments to IFRS: Isomorphism and resistance
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and Gendron, 2011).
What the preceding discussion highlights is the functioning of two opposing forces which can shed light on the development of the professional accounting space. Continuous improvement of the IFRS
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aims to enhance the relevance and reliability of financial reporting and the ability of users to make informed decisions about the stewardship of those entrusted with the management of organisations’ resources and obligations (Barth, 2008; IASB, 2009a; Ravenscroft and Williams, 2009). In this way,
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compliance with IFRS allows organisations to provide decision-useful information to investors and creditors, to mitigate agency costs and to provide a source of pragmatic legitimacy (Hopwood, 1987; Barth, 2008; IASB, 2010a). Adherence to the codified set of principles and rules is also a means of replicating financial reporting practices which are generally accepted, being applied in many jurisdictions by numerous organisations (Brown, 2011; IASB, 2012; Murphy et al, 2013). Furthermore, using IFRS is presumed to result in financial statements which achieve fair presentation,
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serving the general information needs of primary users of the financial statements (IASB, 2010a). The result is that compliance with international standards is an important source of organisational legitimacy.
The same logic applies to the recent release of IFRS 10 and IFRS 12. As discussed in more detail in
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Section 4, the standards formalise and enclose the consolidation accounting space providing a technical rational reporting discourse which preparers must adopt to achieve ‘fair presentation’ (see
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IASB, 2010a). Concurrently, the preparation of consolidated financial statements has been aligned with generally accepted best practice for communicating a particular economic position to users of the financial statements (see IASB, 2011a), making non-compliance difficult to justify. That IFRS 10 and IFRS 12 are introduced in the interest of corporate transparency and accountability reinforces the effect of isomorphic pressures on the regulated. This is especially true given that the standards are a direct response to global financial crisis and are deemed misapplications of consolidation accounting principles, as discussed in Section 3. We say ‘reinforce’ rather than ‘ensures’ because, as explained by Tremblay and Gendron, these accounting prescriptions are ‘interpreted and enacted by complex and oftentimes unpredictable human beings’ (2011, p. 260). Dynamic capital markets where preparers are required to interpret and apply accounting prescriptions can lead to a divergence between the intended application of new accounting 9
ACCEPTED MANUSCRIPT standards and their actual use. Added to this is the risk of legalistic application (McMillan, 2004), ‘self-preservationism’ (Roberts, 2009) and the inherent complexity of contemporary corporate environments leading to varied application of the IFRS’s (consider Cooper and Robson, 2006; Barnes, 2011; Karampinis and Hevas, 2011). In turn, the tension between isomorphic forces and a logic of resistance can shed light on how
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international accounting standards develop over time (Rodrigues and Craig, 2007), in particular, when it comes to IFRS 10 and IFRS 12. Section 3 discusses how the IASB has a history of responding to perceived misapplication of consolidation accounting principles (see Hsu et al, 2012). Adapting the model of thesis versus anti-thesis developed by Rodrigues and Craig (2007), coercive, normative and mimetic pressures can be seen as driving compliance with accounting prescriptions developed by the
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IASB (thesis). Nevertheless, a logic of resistance (anti-thesis) means that new regulations (such as those found in IFRS 10 and IFRS 12) are not automatically interpreted and applied as intended by the
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standard setter. Accordingly, the development of consolidation accounting can be interpreted as a synthesis of the effects of isomorphism and a prevailing logic of resistance (Rodrigues and Craig, 2007; Durocher and Gendron, 2014). Before discussing this in more detail, a brief history of the consolidation accounting is provided.
3: The introduction of IFRS 10 and IFRS 12
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IAS 27: Consolidated and Separate Financial Statements (IAS 27), originally issued in 1989, used a control-based model to identify subsidiaries4. It defined ‘control’ as the power to govern the operating and financial decisions of an entity so as to benefit from its activities, normally evidenced by a majority shareholding (IASB, 2008). To represent faithfully the economic reality of a parent having
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control over one or more subsidiaries, the financial position, performance and cash flows of the subsidiary companies needed to be consolidated with the parent’s, resulting in a set of ‘consolidated financial statements’5. These presented the activities of the group as a single economic unit (IASB,
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2008; IASB, 2009b). Due to the narow wording of IAS 27 it was, however, possible intentionally to avoid having to consoldiate an entity under one’s control. This was frequently achieved by ensuring that the parent had a limited shareholding in the subsidiary but was still able to govern the financial
4
IAS 27 was issued in 1989 and was amended in 2003. At this time, the IASB did not reconsider the fundamental approach to consolidation of subsidiaries in IAS 27. In 2011, IAS 27 was superseded by IFRS 10 and IAS 27: Separate Financial Statements. 5
For the purpose of preparing a consolidated set of accounts, IAS 27 required certain ‘consolidation adjustments’ to be processed such as the elimination of intercompany balances and the parent’s investment in the subsidiary company against that company’s equity at acquisition. Further discussion of these principles is beyond the scope of this paper.
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ACCEPTED MANUSCRIPT and operating policies of the company other than by direct voting rights6. The limited direct equity interest by the parent, coupled with the difficulty of demonstrating how the parent derived direct economic benefits from the ‘special purpose entity’ (SPE) or ‘vehicle’ (SPV), resulted in circumvention of the requirements of IAS 27 (see IASB, 2011b; IASB, 2011a). In response, SIC 12: Special Purpose Entities (SIC 12) was issued during 1998 (IASB, 2010c). This
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interpretation sought to clarify and broaden the definition of ‘control’ per IAS 27, as a result, widening the consolidation net. Unlike IAS 27 it explicitly dealt with how, if a company was exposed to significant risks associated with the SPV and, in substance, enjoyed significant economic benefits from the relationship with the SPV, it should be consolidated. This would apply even if the parent did not hold the majority of the equity interest in the SPV (IASB, 2010c). The result, however, was that
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preparers interpreted SIC 12 as introducing an alternate model of control that could be interpreted independently of IAS 27. This allowed for a type of arbitrage between the two ‘models’ leading to financial statements7 (IASB, 2011b).
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certain entities remaining unconsolidated, to the detriment of the fair presentation of the respective
The global financial crisis commencing in 2007 made the lack of transparency regarding the application of consolidation principles more apparent, especially given the potential of off balance sheet vehicles to detract from the relevance and reliability of financial statements (IASB, 2011a, IN 5). As a result, the IASB added to its agenda a project on consolidation to address inconsistent
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application of consolidation principles, particularly ‘a perceived conflict of emphasis between IAS 27 and SIC 12’ (IASB, 2011a, IN3 – IN4, emphasis added). In May 2011, the IASB issued IFRS 10 and IFRS 12. The former details the revised definition of
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‘control’8 and consolidation principles (many of which were found in IAS 27 and SIC 12). The latter contains related disclosure provisions (IASB, 2011a; IASB, 2011b). With the release of IFRS 10, the IASB is of the opinion that it has provided additional clarity on the concept of ‘control’, reducing the
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potential for future varied application of consolidation principles (IASB, 2011a). IFRS 10 adopts a ‘step-by-step’ approach to determining control and is more broadly applicable than IAS 27. For 6
For example, an investor holding less than 50% of the voting rights in an investee may still have control over the latter due to contractual arrangements. These entities were often on ‘auto-pilot’ in the sense that their financial and operating policies could not be modified except by their creator or sponsor. These companies were often formed to carry out specific activities on behalf of their investors and were referred to as special purpose entities (SPE’s) or vehicles (SPV’s)
7
Compounding this problem was the fact that IAS 27 and SIC 12 did not deal with a situation where an agent was used to manage the equity interests of a company. It was, therefore, possible for an intermediate (agent) to hold the majority of the equity in a company and appear to have control over that company while, in reality, control vested with the principal (PricewaterhouseCoopers, 2012). Consequently, such companies remained unconsolidated, despite the release of SIC 12 8
IFRS 10 defines ‘control’ as: exposure or rights to variable returns from involvement with an investee, where the investor has the ability to affect those returns by virtue of power over the investee (IASB, 2011a, para 6)
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ACCEPTED MANUSCRIPT example, unlike IAS 27 and SIC 12, it explicitly deals with agent-principal relationships. IFRS 10 explains how to identify principals and agents and determine whether or not an agent or principal has control over the investment in question. Like IAS 27 and SIC 12, it caters for situations where a company controls a subsidiary, despite holding less than 50% of the voting rights. IFRS 10 is, however, more explicit than SIC 12.
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It provides extensive guidance, with principles organised according to a defined hierarchy9, on how to assess whether or not voting rights confer control over an investee and on instances when voting rights do not clearly indicate whether the reporting entity ought to consolidate the prospective subsidiary. It also includes a number of anti-avoidance mechanisms not found in its predecessors, such as provisions for the consolidation of ‘ring-fenced’ assets (IASB, 2011a). The result is a highly
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detailed consolidation standard, complemented by an ‘application guidance’ and integrated examples that makes IFRS 10 considerably lenghtier than IAS 27 and SIC 12 and far less dependent on the
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application of professional judgement (PricewaterhouseCoopers, 2012; Danjou, 2013). Complementing IFRS 10 are the additional disclosure requirements introduced by IFRS 12. The IASB maintains that improved:
‘disclosure of a reporting entity’s interest in other entities [helps to] identify the profit or loss and cash flows available to the reporting entity and [to] determine the
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value of a current or future investment in the reporting entity’ (IASB, 2011c, IN 3). More specifically, there was a desire to increase disclosure regarding entities in which the investor had a ‘special relationship’, including ‘unconsolidated structured entities’10 (IASB, 2011c, IN 6 - IN 7). To this end, IFRS 12 effectively obliges preparers to disclose sufficient information to allow users
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to assess the nature of (and risks associated with) interests in those entities and the ultimate effect on the group’s financial statements (IASB, 2011c). Where a decision is taken not to consolidate a
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structured entity, IFRS 12 requires preparers to disclose the rationale for this. In addition, the nature, objective, size, and activities of the unconsolidated structured entity must be disclosed, including how it is financed and the reason for any financial support from the investor (IASB, 2011c). The result is that IFRS 12 essentially requires sufficient disclosure for users to assess the effect of not
9
Firstly, the user is required to determine whether control is a result of shareholdings in the investee, in which case certain paragraphs of IFRS 10 are applied first. If the conclusion is that control is not evident or not a direct consequence of shareholdings, alternate paragraphs dealing with ‘structured entities’ must be applied. This is elaborated. For example, the indicators in paragraph B18 are considered only in circumstances where it is ‘difficult to determine whether an investor’s rights are sufficient to give it power over an investee’ (IASB, 2011a, para B18). Similarly, the guidance in paragraph B19 and B20 is to be applied sequentially only after paragraph B18 is considered. 10
An entity that has been designed so that the voting rights are not the dominant factor in deciding who controls it (IASB, 2011b, Appendix A).
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ACCEPTED MANUSCRIPT consolidating structured entities (IASB, 2011b; PricewaterhouseCoopers, 2012). The standard is, therefore, integral to the drive for enhanced corporate transparency at the heart of IFRS 10 (IASB, 2011c).
4: Method
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Due to the lack of direct prior research employing an institutional frame of reference for analysing IFRS, a qualitative approach was most suitable (see Brennan and Solomon, 2008; O'Dwyer et al, 2011). As discussed in Section 1, this research highlights how normative, coercive and mimetic isomorphic forces are at work driving compliance with IFRS 10 and IFRS 12. It also examines the presence and functioning of a logic of resistance necessitating an idiographic form of research where
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respondents can ‘interpret and describe the phenomenon in their own way’ (Holland, 2005, p. 250). The intention is not the generalisation of results in a positivist sense. Meaningful and detailed
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engagement with experts is needed to illuminate their perspectives on the application and development of consolidation accounting requirements (see O'Dwyer et al, 2011). This is consistent with the approach of comparable studies where the social construction of corporate governance and mechanisms of accountability are the focal point of the research (see, for example, Holland, 2005; Tremblay and Gendron, 2011).
Using detailed interviews allows the researcher to concentrate on the views of those directly involved
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with the preparation, audit or analysis of financial statements, including commentary from some of South Africa’s leading minds in auditing, financial reporting, financial analysis and corporate governance11. Relying on South African experts was driven by practical and substantive reasons. The authors are based in South Africa making access to interviewees in multiple jurisdictions cost
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ineffective. Despite this limitation, the focus on South Africa was considered appropriate. South African companies have been preparing financial statements using IFRS for several years. In addition, both company law and the JSE’s listing requirements mandate compliance with IFRS for listed
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companies, with the result that local preparers, regulators and academics have a detailed working knowledge of IFRS 10 and IFRS 12. The risk of over-emphasising the South African context was mitigated by the international relevance of the IFRS’s and the fact that many interviewees had international work experience, are based at multi-national organisations or are academics or regulators with detailed understanding of financial reporting developments in different jurisdictions. Furthermore, the researchers commenced each interview by describing the objective of the research and the fact that the study was intended for an 11
The researchers did not take into account the respective companies’ accounting/investment policies or technical accounting manuals/reports. These contained only generic information which did not add substantially to the analysis.
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ACCEPTED MANUSCRIPT international audience. Finally, the researchers relied on a fairly diverse group of interviewees. Although the sample of participants was driven to a large extent by ease of access and availability, the researchers focused on respondents who had a detailed practical understanding of consolidation accounting (Appendix B). The final sample of twenty three respondents included preparers from large listed companies who were involved in preparing consolidated financial statements, audit partners with experience on large group audits and analysts from the country’s investment houses (adapted
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from Holland, 1998a; Durocher and Gendron, 2014). To ensure a diverse range of opinions, each ‘class’ of respondent was equally represented12. It should, however, be reiterated (see Section 1) that this was to avoid the risk of response bias and not to evaluate in detail the nature of and reasons for differences in the perceptions of stakeholder groups.
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Potential interviewees were contacted either by telephone or by e-mail and invited to participate in the research. As a quality safeguard, they were informed of the nature and purpose of the research and
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guaranteed anonymity. A time was scheduled to meet with each interviewee and an outline of the research project, including a list of open-ended questions, was made available at least three working days before each interview. These questions addressed the possible operational effects of IFRS 10 and IFRS 12, including the rationale for introducing the new standards13. The questions centred around three main themes: whether or not the new standards achieved an added sense of corporate transparency and accountability; the extent to which the IFRS defines and codifies consolidation principles; and the possibility of the prescriptions of IFRS 10 and IFRS 12 being circumvented, as
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was the case with SIC 12. The questions were piloted during July 2012 with two academics at one of the country’s leading universities and two audit partners from one of the Big 4 audit firms in South Africa.
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Time was spent establishing rapport with the respondents who were encouraged to speak with complete candour; were reminded of their right to withdraw from the study at any stage; and were asked to agree to the recording of their interviews. Twenty-three interviews, each lasting between 45
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minutes and 3 hours were conducted in Johannesburg and Pretoria from October 2012 to May 2015. All interviews were semi-structured. On occasion, respondents were asked to explain a particular concept or statement in different words or from different perspectives to address ‘script coherent expressions’ or resolve any ambiguities (Alvesson, 2003). Although the sequence in which the issues
12
The fact that several respondents provided critical perspectives that challenged the status quo suggested that the interviews were not dominated by a single perspective.
13
IFRS 10 and IFRS 12 are only effective for annual periods commencing on or after 1 January 2013. While some respondents had encountered or dealt with the application of the new standards, others had not. In these instances, interviewees discussed the expected impact of the new standards. While this may be regarded as a threat to validity and reliability in a positivist sense, hypothetical reasoning is an accepted characteristic of interpretive studies (Llewellyn, 2003). In addition, due to the fact that interviewees have considerable experience with the IFRS, they were able to provide valuable opinions.
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ACCEPTED MANUSCRIPT were addressed – as well as the detail provided by each respondent – varied, the same themes were covered during each interview and the same point was used to commence each interview, namely: the requirement of IFRS 10 to prepare consolidated financial statements (adapted from Holland and Stoner, 1996; Holland and Doran, 1998; O'Dwyer et al, 2011). At no time did any of the interviewees express concerns about the nature of the study. Respondents’ motivation for participating in the study
these standards were or were not being applied in practice.
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appeared to come from their desire to discuss the technical aspects of IFRS 10 and IFRS 12 and how
In order to generate findings, the researchers analysed each transcript and made initial notes on the content. Theme categories (open codes) were used to group the contents of transcribed interviews.
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The ‘theme register’ included, inter alia, (1) technical analysis of IFRS 10 and IFRS 12, (2) the reasons for the introduction of the standards, (3) compliance pressures, (4) corporate transparency and accountability, (5) servicing information needs of stakeholders, (6) divergence in the application of
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IFRS 10 and IFRS 12 and (7) a logic of resistance.
This process was very detailed and time-consuming. It involved the researchers analysing each transcript and comparing and contrasting perceptions of respondents. In particular, emerging principles or themes pointing to the functioning of isomorphic pressures were identified. These were juxtaposed with arguments refuting the position that IFRS 10 and IFRS 12 are complied with. All
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notes were then numbered and cross-referenced to an open code register to allow for easy data analysis. Initial notes were contrasted and general data categories and interconnections were identified using a type of ‘data mind map’.. As part of this process, follow-up questions were raised if needed. The findings and substance of initial interpretations were not altered by the follow-up sessions
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(adapted from: Parker and Roffey, 1997; Leedy and Ormrod, 2001; Creswell, 2009; O'Dwyer et al, 2011; Rowley, 2012).
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To retain the study’s exploratory focus, the open codes were not predefined. Instead, they were interpretively developed by the researcher, based on the analysis of the prior literature (Section 2) and the initial review and contrast of interview transcripts. Naturally, this was an iterative and subjective process with coding of transcripts, cross referencing with the prior literature and refinement of the open codes occurring until a sense of saturation of the data was obtained. As part of this process, codes with few or no allocations were aggregated (adapted from Parker and Roffey, 1997; O'Dwyer et al, 2011; Maroun and Atkins, 2014). The final product was a ‘summary table’ for each transcript which effectively ‘assigned’ the transcript content to different content ‘pools’, each of which is aggregated under a finalised set of axial codes. These included codes for coercive, normative and mimetic isomorphic pressure and the nature of resistance to the application of IFRS 10 and IFRS 12.
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ACCEPTED MANUSCRIPT These codes were interpretively developed by the researchers to aggregate the main reasons for companies complying with, or resisting the prescriptions of, IFRS 10 and IFRS 12 according to the interviewees. The axial codes were refined based on discussions with participants at two international accounting conferences and informed the use of subheadings in the results section14. This did not detract from the exploratory nature of the study. Instead, it ensured a methodical analysis of the interview transcripts, allowing the main points being raised by interviewees to be analysed with a
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clear focus on the primary objective of this paper : exploring sources of isomorphic pressure which encourage compliance with IFRS 10 and IFRS 12 and the relevance of a logic of resistance (adapted from: Oakes et al, 1998; Holland, 1998a; Holland, 1998b; Leedy and Ormrod, 2001; Maroun and
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Atkins, 2014).
At this point, it should be stressed that the emphasis was on a broad examination of experts’ experiences and perceptions. Where a particular ‘class’ of respondents expressed a particular view on
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IFRS 10 and IFRS 12 this was noted and has been highlighted in the results section. It was, however, difficult to discern if there were significant divergences in the opinions of the different types of respondents. This is probably the result of the small sample size and related challenge of generalising results (Durocher and Gendron, 2014). It should also be pointed out that, due to the technical nature of the research subject matter, all of our respondents are professional accountants. As such, the inability to draw inferences on relevance of the identity or role of respondent for the functioning of isomorphic
5: Findings
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pressure and a logic of resistance should be interpreted with caution.
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5.1: Isomorphic pressures to comply with IFRS 10 and IFRS 12 Our interviewees identified various motives for complying with the requirements of IFRS 10 and IFRS 12. A systematic analysis of the interview findings, as discussed in Section 4, was used to
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identify key principles or themes which summarised the main reasons for adherence to the financial reporting prescriptions contained in the new standards. The findings are summarised below15. 5.1.1: Compliance with laws, regulations and stakeholders’ expectations: Coercive isomorphism The data highlights two primary coercive pressures to comply with IFRS 10 and IFRS 12: formal legal requirements and the informal operation of general cultural expectations 14
We would like to acknowledge one of the anonymous reviewers at an accounting conference who provided us with this most helpful recommendation. 15
Special thanks go to the conference participants at the International Corporate Governance Conference (2012) and GARI Conference (2012) for their assistance with the development of these codes. The authors would also like to thank one of the anonymous reviewers who recommended using the axial codes to provide more structure to the results.
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ACCEPTED MANUSCRIPT Legal requirements: Explicit isomorphic pressure Many interviewees cited legal requirements as the primary reason for compliance with IFRS 10 and IFRS 12. For example: ‘Why do we comply with IFRS 10? As I said, you can’t very well just ignore the explicit requirements of the IASB. But you also need to remember that the Companies Act makes
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it mandatory for us to use IFRS as our financial reporting framework. You’ve got to adhere to the country’s rules and regulations! If you don’t, you’ve acted contrary to the law! And that’s not going to fly.’ (R20)
Legal requirements represent a powerful institutionalised system which contemporary organisations
1995).
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must comply with to secure structural and procedural legitimacy (Meyer and Rowan, 1977; Suchman, When it comes to IFRS 10 and IFRS 12, for an organisation to be accepted as credible, it
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needs to be seen as acting in accordance with Company Law which requires financial statements prepared in compliance with IFRS16 (R20). Reinforcing this are the JSE’s requirement for listed companies to comply in all material respects with the international accounting standards in order to secure or maintain access to the local capital market (Johannesburg Securities Exchange, 2013). In addition, one respondent pointed out how,
‘You may find that we have particular contracts with important suppliers, customers or
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financiers which require us to disclose information about our group structure and transactions and balances in terms of IFRS 10. You have to comply with that if you want to do business with them’ (R10).
As explained by DiMaggio and Powell (1983, p. 151), the legal and technical requirements of
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powerful stakeholders ‘support the homogenisation of organisational models’. Coercive isomorphism can, however, function more subtly as evidenced by respondents’ interpretation of the relevance of
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revised consolidation accounting standards (Section 3) at a time when the South African capital market is becoming more aware of the importance of faithful and balanced corporate reporting (Atkins and Maroun, 2014).
Societal expectations as a subtle source of coercive isomorphic pressure: Over and above the legal requirement to comply with IFRS 10 and IFRS 12, coercive isomorphic pressures arise from the expectation ‘that organisations ought to be transparent’ (R9) and ‘consolidate those entities which they genuinely control’ (R22). With stakeholders’ confidence in the corporate
16
There may be instances where companies are able to use an alternate reporting framework. This is, however, beyond the scope of this research.
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ACCEPTED MANUSCRIPT reporting paradigm shaken by corporate scandals and financial crisis (R7; R12; R21), all preparers confirmed that there was an increased propensity to provide additional disclosure and ensure the consolidation of structured entities to conform to societal expectations. This went hand-in-hand with commitment to provide high quality consolidated financial statements ‘by ensuring that when you do, in substance, have control of a subsidiary…you include it in the consolidated financials’ (R15). In other words, there is a sense of pressure to meet stakeholders’ expectations for a complete set of
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consolidated results:
‘Look, it’s quite obvious that the emphasis is on transparency. You only have to read King [III] and the discussion papers on integrated reporting. People expect us to be more open in our reporting. Now, more than ever, you cannot afford to be in a situation where
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– after Enron and everything that’s been going on at the American banks – you are perceived as using the loopholes in SIC 12 and IAS 27 to avoid consolidating something.
produce high quality reports! (R20)’.
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I can tell you right now that that won’t fly. There is an expectation that you comply and
For many of the preparers and their auditors there is a sense of a fiduciary duty to stakeholders (cf DiMaggio and Powell, 1983). In particular, the proliferation of codes of corporate governance (Solomon, 2010) and the advent of integrated reporting (IOD, 2009) confirm stakeholders’ expectations for high quality, transparent corporate reports (see, for example, IOD, 2009; Solomon,
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2010; IIRC, 2011) with which respondents felt obligated to comply (R15; R22) ‘I really do think that you have to comply with IFRS 10. If you are really committed to the principles of good governance and you are committed to the users of your financials, you are not going to just disregard what the IASB tells you to do. Your major
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[stakeholders] just won’t tolerate that.’ (R22, emphasis added). Adherence to the disclosure prescriptions of IFRS 12 becomes part of demonstrating how the reporting
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entity is conforming with societal expectations for additional disclosure on SPV’s (consider IASB, 2011b) which encourages stakeholders’ confidence and confers credibility (R2; R6). For example:: ‘Taken together [IFRS 10 and IFRS 12] have opened up the company more than before. It’s more transparent and we will see this in terms of what kinds of disclosure you get…and this added transparency makes it easier to trust that company’(R7, emphasis added); According to Di Maggio and Powell (1983), organisations can be subject to subtle coercive pressures to conform to the structures and policies of those on whom they are dependent for support. What the above comments highlight is the importance placed on IFRS 12 disclosures by users and, accordingly,
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ACCEPTED MANUSCRIPT how compliance with the accounting standard becomes a means of signalling that the organisation is responding to the concerns of important constituents regarding the unconsolidated SPV’s (see Section 3). Collectively, the application of IFRS 10 and IFRS 12 are, therefore, about adherence to minimum reporting standards which ‘your large shareholders and other important users of financial statements are demanding’ (R22).
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To the extent that the financial statements are seen as non-compliant with IFRS 10 and IFRS 12: ‘[This]… tells you that they aren’t interested in being transparent and that their [corporate governance] is up to shit. You can’t work with those people. They either comply with [IFRS 10] or you can’t rely on their financials. You will probably sell out’ (R21).
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Summary
The above discussion highlights how stakeholder expectations for faithful and transparent corporate
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reporting complement the effect of Company Law and listing requirements mandating compliance with IFRS 10 and IFRS 12. As explained by DiMaggio and Powell (1983), these formal and informal pressures to adhere to reporting obligations and to meet societal expectations are a source of coercive isomorphism which, by promoting conformance to the dictates of influential stakeholders, become an
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important means of securing legitimacy (cf Suchman, 1995).
5.1.2: Compliance with technical rational reporting requirements: Normative isomorphism In addition to the effect of laws, regulation and societal expectations, the data analysis identified the
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importance of normative isomorphic pressures. The source of this include: (1) the technical detail of IFRS 10 and IFRS 12; (2) a sense of procedure and structure when applying consolidation accounting principles and (3) evidence of an epistemic commitment to the consolidation knowledgebase. Each of
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these is discussed below.
Technical rigour of IFRS 10 and IFRS 12 Respondents explained how the efforts of the IASB to define more precisely when one entity has control over another makes it difficult to bypass consolidation accounting. For example: ‘I think what they [are] trying to do with the implementation [guidance] is to give you rules for applying those principles [referring to the provisions in IFRS 10]. And I think what is going to happen is that as more and more schemes are
19
ACCEPTED MANUSCRIPT uncovered, where they are trying to keep consolidations off17, I think they’ll just expand the [application guidance] to capture all of those things. That’s where I see things going’ (R7, emphasis added). By providing a more comprehensive basis for determining when one entity has control over another, auditors, preparers and analysts generally agreed that the result was the reduction of ambiguity in the
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accounting standards and this added pressure to comply. ‘IFRS 10 was about closing that loophole’ (R3). [The standard is] a response to non-consolidation of entities…where there was real risk exposure and the reader
could never discern it’ (R2). ‘[Ultimately], the IASB wanted more consolidations
probably going to get precisely that’ (R20).
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Procedures, rules and motifs of disciplinary power
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than IAS 27 seemed to provide’. (R1). ‘And with IFRS 10 and IFRS 12, it’s
Respondents noted that changing economic circumstances have contributed to the refinement of consolidation principles As explained by one expert
‘More transactions occur and these become more complicated. Maybe circumstances arise that you never thought of originally when [the standard
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setters] conceived the concept of subsidiaries and consolidations’ (R3). This technical perspective was, however, complemented by commentary which suggested that structure of IFRS 10 and IFRS 12 is a source of isomorphic pressure. On one level, this pressure is coercive in nature, especially if the requirements of the accounting standards are treated as a discourse
Miller, 2012).
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characterised by elements of disciplinary power (Foucault, 1977; Foucault, 1983; Mennicken and
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While a detailed analysis of Foucauldian theory of power and control is beyond the scope of this paper, it is interesting to note that many interviewees felt that IFRS 10 and IFRS 12 have allowed the concept of control and consolidation to be disaggregated into a step-by-step process (R9; R19). The actual consolidation exercise is no longer a technical professional one but is a series of functions or activities which are ‘segregated’, sequenced and disclosed (consider Hopper and Macintosh, 1993; Cowton and Dopson, 2002). This is highlighted by the following comment from a local preparer: ‘IFRS 10 follows a very systematic method. First, you have to look and see if you have power over the investee and the standard gives you two “decision trees” 17
In other words, trying to avoid the consolidation of an entity when doing so will be in their (preparers’) best interests.
20
ACCEPTED MANUSCRIPT which you must work through, You must check to see if you have control because of voting rights, and if that is not the case, if you have a structured entity. In each case, the standard tells you exactly what to look for. Then you decide if you have exposure to variable returns and if you are acting as an agent or principal. At each stage, the standard refers you to the application guidance for step-by-step guidance’
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(R22). ‘Clearly spelled-out rules’ (R5) complement this by addressing past experiences of non-compliance and ‘enclosing’ the consolidation accounting space (R21). The result is that most of our interviewees felt that the added detail in the standards; use of extensive examples; a lengthy application guidance; and hierarchical process for identifying a parent-subsidiary relationship are designed to ‘condition you
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to think about consolidations in a particular way’ (R13) and encourage compliance with the ‘the increasingly rules-dependent approach in IFRS 10’ (R9). The effect is summarised by one expert:
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‘You will notice that IFRS 10 is much longer than SIC 12 and IAS 27. It often repeats itself and has a very long appendix that’s full of examples and specific rules...They [the IASB] probably wanted to drum the main points in our heads and show us specific cases where there have been problems in the past, to make sure that
Epistemic commitment
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preparers apply IFRS 10 as intended’ (R18)
A sense of commitment to the principles or cognitive base of consolidation was also evident (cf Durocher and Gendron, 2014). This does not depend on Foucault’s (1977) conceptualisation of
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disciplinary power but does take into account how technical accounting discourse and an underlying cognitive legitimacy are a source of normative isomorphic pressure (Smart, 2002; Rodrigues and
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Craig, 2007).
The formal structure of the accounting standards; a clearly defined consolidation process and the use of illustrative examples allow the prescriptions of IFRS 10 and IFRS 12 to constitute a generally accepted methodology (see Meyer and Rowan, 1977; Suchman, 1995; Power, 2003).
These
contribute to a sense of technical rigour which is important for securing procedural and structural legitimacy (Suchman, 1995) With stakeholders unable to observe directly the financial reporting process, statements on compliance with the ‘sound practices’ (R6; R9) described by IFRS 10 and IFRS 12 secure legitimacy for the reporting entity by relying on generally accepted confidence in a clearly defined, well-developed, cognitive base (see DiMaggio and Powell, 1983).
21
ACCEPTED MANUSCRIPT That the accounting standards are applied by multiple jurisdictions, have the backing of stock exchanges and enjoy the force of law, simply serves to emphasise the legitimising potential of compliance with the IFRS18 (R1; R7; R22). By then appealing to the need to respond to weaknesses in the prior definition of ‘control’ (R5); safeguarding against a lack of prior reporting transparency (R9); and serving the information needs of users of financial statements more efficiently (R17), the release of IFRS 10 and IFRS 12 has become integral to maintaining confidence in consolidation accounting
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practices. The result is the reinforcement of consolidation techniques as a taken-for-granted part of the accounting paradigm and, accordingly, something which preparers ought rationally to comply with to ensure their legitimacy in the eyes of stakeholders:
‘… the rationale behind IFRS 10 is that you have to consolidate what you control.
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It’s an activity-based standard. If you control something, you’ve got to show in your accounts that you’ve directed those activities. Anything else doesn’t make
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sense because it [consolidation] is a concept in our accounting standards. Why is this concept in our accounting standards? You don’t need to go that far. I don’t know exactly why, but that’s just the way it is. We comply with IFRS 10 because we must’ (R6, emphasis added).
IFRS 10 entrenches a generally accepted assumption that legitimate financial statements are those in which subsidiary companies are consolidated (R1; R10) resulting in adherence to consolidation
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accounting principles and techniques. Similar to the findings of Durocher and Gendron (2014), there is also a sense of confidence that the IASB understands the needs of users of financial statements and that the development of the new accounting standards as a means of improving corporate reporting (IASB, 2010) can be accepted as a statement of fact. To this end, it is conceivable that alternatives to
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consolidation are possible (R3; R18). The principle of control and consolidation has, however, become an inextricable part of day-to-day accounting practice to the extent that, for some respondents, a failure to consolidate an entity when it is under the control of another amounts to a
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failure to achieve fair presentation and, in essence, the failure to issue a legitimate set of financial statements (R7; R9; R20; R22): Summary
What interviews with prepares, auditors and investors
highlight is the existence of normative
pressures to adhere to the prescriptions of IFRS 10 and IFRS 12. With consolidation generally accepted as a rational and legitimate means of communicating a particular economic reality, a conformance strategy is a means of aligning the organisation’s financial reporting with accounting 18
Further discussion on the reasons for the globalization of IFRS, including the evolution of capitalist systems, is beyond the scope of this research. What is relevant for this paper is the fact that, as a global set of accounting standards, there is an incentive to demonstrate compliance with IFRS in order to secure legitimacy.
22
ACCEPTED MANUSCRIPT principles which have, in essence, attained a state of cognitive legitimacy. Their taken-for-granted principles allow the new standards to ‘condition…your mind to think in [a certain way]’ (R1), effectively constituting the only discourse for describing ‘control’ and the accounting for the relationship between a parent and its subsidiaries (R9; R20). As explained by Suchman (1995) and Rodrigues and Craig (2007, p. 744), the normative isomorphic pressure of consolidation accounting ‘gains momentum (and hence power) as more people come to accept, as common knowledge, the
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particular views associated with that belief system’. IFRS 10 and IFRS 12 have codified a technical accounting practice. They are ‘accepted without question as the basis for preparing consolidated accounting under the law’ (R2). Added to this is the appearance of a technical rational procedure for consolidating two or more entities backed by due process, detailed research and extensive stakeholder
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engagement on the part of the IASB (R1; R3; R9). The result is that they represent the dominant discourse for describing this particular part of accounting practice and what constitutes a credible set of financial statements. Having attained at state of cognitive legitimacy (see Suchman, 1995),
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compliance with IFRS 10 and IFRS 12 becomes increasingly important for aligning the organisation with constituents’ belief sets and securing social standing (cf DiMaggio and Powell, 1983; Foucault, 1983; Rodrigues and Craig, 2007).
5.1.3: Cognitive legitimacy and the relevance of mimetic isomorphism With consolidation accounting attaining a state of cognitive legitimacy, it follows that adopting the
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requirements of IFRS 10 and IFRS 12 is important for signalling conformance with recommended best practice, avoiding criticism from stakeholders and either gaining or preserving legitimacy (DiMaggio and Powell, 1983; Carruthers, 1995).
One respondent, for example, explained the
decision to adopt IFRS 10 early as follows:
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‘The financial crisis showed us that companies…which had unconsolidated structured vehicles were being hammered for not being open about their group structures. Their
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reputations suffered because they didn’t consolidate and disclose their SPV’s to users. What we decided to do was show that we had nothing to hide. We early adopted so that our investors could see that we were not one of the companies which was using loopholes in SIC 12 and IAS 27 to manipulate the balance sheet and income statement’ (R22). As explained by DiMaggio and Powell (1983) and Suchman (1995), with previous practices subject to criticism, replicating the policies processes or outputs of successful organisations (which have, accordingly, avoided criticism) is a useful strategy for combatting threats to legitimacy. In the context of consolidation accounting, this amounts to rejecting the dual consolidation model under IAS 27 and SIC 12 – which has been associated with the 2007/2008 financial crisis (Section 3) – and signalling to
23
ACCEPTED MANUSCRIPT users how the organisation has embraced the move towards more transparent reporting for structured vehicles. Equally relevant is the need for consistency with peers: ‘Comparability is a key issue when you look at early adopting IFRS 10. On the one hand, you need comparability for the reasons we all read about in the textbooks. You want users to be able to compare investments and ensure efficient allocation of capital. But
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there is also a lot of pressure to make sure that you don’t fall behind. If you are using IAS 27 [and SIC 12] but your major competitor is early adopting IFRS 10 and gives all the disclosure in IFRS 12 your investors are going to start wondering why you don’t do the same’ (R15).
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These comments highlight the concurrent functioning of normative and mimetic isomorphic pressures to comply with the new consolidation accounting standards. As discussed in Section 5.1.2, IFRS 10 and IFRS 12 constitute the generally accepted framework for describing the financial statements of a
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group of companies which achieve fair presentation. This has a powerful socialising effect which encourages compliance (see DiMaggio and Powell, 1983; Fogarty, 1992). By the same token, with the respective accounting and disclosure prescriptions taken for granted, preparing financial statements which are consistent with these standards and other leading organisations already complying with IFRS 10 and IFRS 12 becomes an important source of organisational legitimacy.
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5.2: On the logic of resistance
The above discussion should not be construed as suggesting that the new accounting standards are complied with in every instance. As explained by Rodrigues and Craig (2007), a given position or thesis is often challenged by counter-arguments, inconsistencies and contradictions (antitheses). In the
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context of IFRS 10 and IFRS 12, this is seen in the tension between the drive for compliance with the standards and the continuing relevance of a logic of resistance, the nature and sources of which are
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discussed in more detail below.
5.2.1: Failure to address self-interest and opportunistic behaviour Unlike the ongoing debate on the appropriateness of fair value versus cost accounting (for details in this regard see Ravenscroft and Williams, 2009; Durocher and Gendron, 2014), we find little evidence of respondents challenging the spirit of IFRS 10 or IFRS 12 on conceptual or ideological grounds. Instead, the primary source of resistance to the new accounting standards is rooted in the view that they are not an effective response to opportunistic behaviour undermining corporate transparency (cf Tremblay and Gendron, 2011). More specifically, several interviewees were not convinced that IFRS 10 and IFRS 12 would tackle effectively continuing ‘incentives to move things off balance sheet’ (R10). Consider, for example, the following comments:
24
ACCEPTED MANUSCRIPT ‘What do you do with a loss-making subsidiary?...I have seen how companies will try to find ways to avoid consolidation because they didn’t want to report the failures to their investors and because their bonuses were performance-linked and their stock options were ready to be exercised. Of course, that’s not what they tell the public or their auditors. Instead, they use very complicated contracts to obscure the economics and
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confuse the auditors and make it seem like you don’t have to comply with IFRS 10” (R3) Classic agency problems undermine efforts to enhance the financial reporting system (see also Pesqueux, 2005; Malsch and Gendron, 2011). For several respondents (including both auditors and investors) IFRS 10 and IFRS12 do not do enough to mitigate completely the risk of capitalistic pressures on preparers to avoid consolidating structured vehicles when it is in their best interest do so.
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Related closely to this is the view that IFRS 10 and IFRS 12 ‘can’t make people more ethical’ (R9). Focusing on the technical features of consolidation accounting may reduce instances of
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misapplication of professional judgment but do not and cannot change the mindsets of those who have ‘commercialised finding ways to circumvent the requirements of IFRS 10 and IFRS 12’ (R22). In this context, many auditors and preparers were especially critical of the investment banking fraternity: ‘The [new standards] come up with a lot of extra information and give plenty of examples to make life more difficult for people who are already complying with IFRS and do nothing at all for the investment bankers of the world who were misapplying the
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accounting before IFRS 10; who are currently misapplying it to suit their interests; and will misapply the consolidation rules that the IASB come up with after the next crisis’. When asked if the negative views on investment bankers were only a result of the global financial
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crisis, one respondent stated:
‘That had a lot to do with the exceptionally complicated financial structures which the
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investment bankers (and their lawyers) used to do business…I think that a lot of this had to do with how they chose to consolidate or justify not consolidating some of the structures they were using to finance these deals. What has IFRS 10 and IFRS 12 done to stop this? Very little because all the IASB can do is come up with additional rules but those rules don’t take the money out of doing these deals and so the bankers’ own greed will continue to drive new ways to avoid consolidation’ (R22). As explained by Tremblay and Gendron (2011), resistance is mobilised by the belief that additional rules and regulations are not effective for tackling wayward agents, coupled with the position that non-compliance by at least some stakeholders is inevitable (p. 266). Respondents do not describe the technical details used to circumvent IFRS 10 and IFRS 12 but their views are important for showing
25
ACCEPTED MANUSCRIPT how negative sentiment weakens the link between improving consolidation accounting in the aftermath of the financial crisis (Section 3) and the operation of coercive, normative and mimetic isomorphism (Section 5.2). 5.2.2: Legalistic application of IFRS Initially, the preceding discussion can be interpreted as implying that resistance to IFRS 10 and
structuring transactions. This view can be dismissed:
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IFRS 12 is only hypothetical, possibly because their recent release has not allowed adequate time for
‘Only a few days ago, I got a call from [a colleague] who wanted to know how a deal could
be
structured
to
keep
an
SPV
off
of
the
books
under
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IFRS 10 because they were worried about the impact for [certain contractual guarantees].What was even more important was the attention from some of the investors
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and analysts. [The preparer] was very concerned about what IFRS 10 would do to the key ratios and the risk disclosures [required by IFRS 12 and IFRS 7]’ (R21). The researchers identified legalistic interpretation of the IFRS’s as a key mechanisms of resistance used to circumvent consolidating structured vehicles. One preparer, mindful of the pressure to ensure transparent reporting (Section 5.1.1), explains as follows:
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‘You obviously can’t turn around and say: “I am not going to consolidate this”. There are laws and contracts that you have to adhere to. Also, you will burn yourself with the investors and at the audit committee because these people put tremendous pressure on you to comply with IFRS. So you have to be smart and justify what you do in terms of
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the IFRS’ (R3, emphasis added).
Resistance does not take the form of overt departures from the standards. Instead, it is relying on the
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complexity of the standards and an interpretation of the rules and principles found in IFRS 10 and IFRS 12 to achieve a desired outcome: ‘What we are seeing is some of our clients analogising to the examples in IFRS 10. They take their transaction and then compare it line-by-line to the illustrative example which explains why you should consolidate….[They] start saying: But my scheme doesn’t fit exactly [into] example 14 so I don’t have to [follow that] example’s treatment…Bear in mind that the examples are part of the standard and are, therefore, authoritative. So, what some preparers are doing is saying “this example tells us what the IASB actually had in mind and how they want us to apply the relevant principles and because my transaction is not exactly the same that must mean that I don’t have to follow this example and consolidate” (R10). 26
ACCEPTED MANUSCRIPT ‘Don’t forget that IFRS is still based on principles and these can be difficult and subjective to apply…Very often, [clients] want to read the IFRS like a piece of legislation and ignore the principles or spirit of the IFRS. Some of the guys are looking at the rules in IFRS 10 and finding ways to interpret them differently to try and get a desired outcome and pay lip service to compliance with IFRS’ (R23).
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Most of the auditors interviewed by the researchers were not prepared to provide specific examples on the grounds of client confidentiality but one was willing to share an issue raised during a technical training session:
‘IFRS 10 refers to exposure to variable returns as an indicator that you have control over
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the investee. From the Basis of Conclusion we know that this is intended to mean an exposure to risk and rewards but there have been cases where the term is being interpreted very literally. My understanding is that a client created a synthetic instrument
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which includes a type of collar and they argue that the instrument pays returns linked to the company’s performance but that they are hedged on the fair value movements and are not exposed to variable returns. When you argue that the economics [are such] that they are exposed to residual risk and rewards and that the collar should be treated separately to give effect to the economics of the transaction, they come back with a very rigid (but correct) view that IFRS 10 does not refer to residual risk and reward or tell you to look at
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hedge they have created separately’.
As discussed in Section 5.2.2, the cognitive base underlying IFRS 10 – complemented by very detailed application guidance and extensive illustrative examples – is an important source of normative isomorphism which drives compliance. Paradoxically, this link between adherence to
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IFRS 10 and organisational legitimacy also means that overt demonstrations of defiance do little to impress stakeholders (R2; R3; R9). The result is that IFRS 10 and IFRS 12 are encouraging a
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legalistic application of the standards, contrary to the principles-based approach being advocated by the IASB. This allows some preparers to structure their results while maintaining that they conform with IFRS on technical grounds (R2; R14; R21): ‘I know of 3 or 4 cases where the client walked a very fine line but their arguments couldn’t be faulted because their particular case didn’t fit exactly with the paragraphs which we were relying on [in IFRS 10]. It came down to judgement. They argued their point and because of the technicalities and because we could not get consensus on whether what they had done was clearly wrong, we had to let it go’ (R6).
27
ACCEPTED MANUSCRIPT Despite the efforts of the IASB, IFRS 10 and IFRS 12 do not achieve a complete enclosure of the consolidation accounting space. The inherent complexity of transactions, and subjective application of IFRS by practitioners, means that it is simply impossible for the accounting standards to cater for every type of transaction which could give rise to a parent-subsidiary arrangement. As one expert summarised: ‘The transactions are complex and the standards are subjective. This leaves people with
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room to manoeuvre and structure transactions to achieve a specific outcome’ (R22). Almost all respondents were, however, critical of rules-based approach for addressing this problem arguing that this had done little to prevent financial scandals in the U.S.A. The consensus was that accounting standards have to provide principles which guide faithful presentation to ensure that they remain sufficiently flexible to cater for dynamic capital markets. As explained by two preparers, there
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are essential principles which can be applied to ensure that the underlying economics of innovative transactions are communicated faithfully to users of the financial statements (R1; R2). In this way,
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adoption of the requirements of IFRS 10 and IFRS 12 as part of a prudential reporting strategy is an important (and favourable) form of resistance to a rules-based accounting system. Nevertheless, the opportunity cost of principles-based standards is the risk of varied application of the guidance provided in IFRS 10 and IFRS 12 due to differences in professional opinion (R2; 7; R9) and the very real possibility of principles being manipulated when it is in the best interest of preparers to do so (R6; R22; R23).
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5.2.3: Denying relevance and rationalising non-compliance From a slightly different perspective, resistance is enabled by the ability to pay lip service to new prescriptions without the need for substantial reforms (Tremblay and Gendron, 2011). For example, a
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number of preparers pointed out that IFRS 10 and IFRS 12 had widened the consolidation net and had introduced potentially significant changes which, in their view, would have far-reaching implications for corporate reporting in their respective sectors. When, however, probed for examples specific to
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their organisations, the researchers were assured by several interviewees that new standards would have little direct effect. Evidence of pre-adoption impact assessments or detailed post-implementation reviews was not available.
Reflecting on the possibility of legalistic application of IFRS 10 and IFRS 12 (Section 5.2.2) and how companies were quick to dismiss the impact of the new standards on their business, one analyst felt that: ‘There is obviously no desire to “comply” in the true sense of the word. When these people say that [their transaction] did not fit exactly into this or that paragraph [of IFRS 10] or one of the examples but then say that they still comply with IFRS, what does that tell you? It tells me that it’s all about impression management. You say one thing to the 28
ACCEPTED MANUSCRIPT users but the reality is that you don’t really want to adhere to what the IFRS tells you to do if that doesn’t give you your desired outcome’ (R19). Respondents agreed that the legal and listing requirements to comply with IFRS 10 and IFRS 12 are sufficient to prevent preparers from overtly departing from the accounting standards (Section 5.1.1). Consequently, for the preparer seeking a particular accounting outcome which is inconsistent with the
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IFRS, the accounting standards must be adopted symbolically and kept separate from the actual accounting positon. As discussed in Section 5.2.2, legalistic application of the standards and reliance on professional judgement are used to circumvent consolidation accounting but maintain that the entity has (on strict reading of the standards) complied with the relevant prescriptions. As this approach becomes more common, it leads to a reflexive legitimisation of resistance strategies. This is
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explained by one respondent as follows:
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‘Once you have anything which preparers would like to avoid, you develop an industry around it. … The genesis of what actually happens in practice is [the company] would get the latest standards and then the merchant banks and financiers would go through that accounting standard and say: “Well, those are the accounting requirements where you have to account for [this transaction in a particular manner]. So we’ll just structure it…so it just falls out of those requirements... Because there was a rule that said [this
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accounting only applies if the holding is at] 90%. So, okay, we’ll make it 89%... If you want a result, there is a market for people who develop it for you. And, of course, even though you have this scheme, you can still tell the users that you comply in all material respects with the IFRS….This happened before [referring to IAS 27 and SIC 12] and it
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is probably going to be the same with IFRS 10 [and IFRS 12]’ (R2). This expert makes two important points. Firstly, to paraphrase Tremblay and Gendron (2011, p. 266), resistance is predicated on the view that ‘history will repeat itself’ and that regulation is ‘an
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ineffective means to solve challenging and enduring problems’ (see also Section 5.2.1). The alleged inevitability of this outcome (R2; R9; R22) does not condone explicit instances of non-compliance but it lessens their impact by suggesting deviations from IFRS are a logical (and possibly natural) part of the regulatory process (R9; R13). Secondly, there is an indication of the institutionalisation of mechanisms of resistance which are legitimised by a rational technical professional process dedicated to legalistic interpretation of accounting requirements. Expert: ‘I am not going to lie. As [a technical accounting expert], you do get calls from people asking you if they do X, Y and Z, will this allow them to avoid consolidating something. I had three of these calls just this year. They are looking for someone who they can say is an independent expert to sign-off on what they are doing’ (R3). 29
ACCEPTED MANUSCRIPT Researcher: ‘What are they doing?’ Expert: ‘Opinion shopping. They know that they have an SPV and they are looking for someone credible to confirm that what they are doing is in line with IFRS 10 or rather that what they are doing is not inconsistent with it’.
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Researcher: ‘Is this unusual? Expert: ‘No - As far as I know, there are some divisions in the investment banks and advisory departments that are making a living out of finding ways around IFRS 10. They use a lot of brainpower to come up with these deals which they then sign-off and who is going to have the
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time or inclination to challenge that?’
In other words, a logic of resistance relies on good faith assumption that because the technical experts have interpreted the provisions of IFRS 10 and IFRS 12, management’s position - even if contrary to
5.2.4: Corporate governance
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the spirit of sound financial reporting - is justifiable.
While legalistic application of IFRS, and associated impression management, was identified as the most relevant (and common) form of resistance, some respondents highlighted the importance of business ethics, corporate governance and the function of internal and external audit. For example,
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one expert made the following comment on the relationship between IFRS 10 and the external auditor: ‘The added detail in the IFRS’s provides auditors with a basis for demanding that a reporting entity consolidated its subsidiaries. But the opposite is also true. It’s also
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possible for the audit firms to rely on the detail in the standard and the complexity of the client’s transaction to justify not consolidating something if they feel that this is in the
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best interest of the business relationship with the client’ (R16). Form a different point of view, one preparer pointed out how the practical difficulties encountered by auditors when determining if the data being tested is completed can also allow SPV’s to go unconsolidated:
‘How would the auditor even know if the SPV is there? If you wanted to, you just don’t show them that contract. In the millions of transactions that happen every day, the chance that they pick up on it is, basically, zero. I mean, we have all been in a situation where the auditor doesn’t ask the question properly. You don’t want to correct them in front of everyone. That would be rude [laughs]’.
30
ACCEPTED MANUSCRIPT As argued by Power (1994; 2003) and Sikka (2009), the complexity of the audit process makes it almost impossible for users of the financial statements to verify the decision to refrain from consolidating a structured entity and the adequacy of the disclosures required by IFRS 12 in these instances. Conversely, the volume of transactions, intricacies of their client’s business models and inherent limitations of risk-based audit means that there is always a risk of non-compliance with
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accounting prescriptions going undetected. Other interviewees placed more emphasis on the role of the board of directors and audit committee. For these experts, IFRS 10 and IFRS 12 offer only a collection of principles and prescriptions. The regulation of their application vests with the governance structures of the reporting entity, in particular, the board and its committees. From this perspective, resistance to IFRS 10 and IFRS 12 are
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not the result of deficiencies in the standard but either weaknesses in or the inherent limitations of the controls put in place by those charged with the organisation’s governance. One preparer (and non-
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executive director) explains as follows:
‘In my experience, you have the biggest risk of unconsolidated structured entities when you have an inexperienced Board or Audit Committee. And the risk is a very real one, especially in some industries. If these guys have their finger on the pulse, they are going to ask the right questions and make sure that their finance teams are consolidating the SPV’s. Where things start to go wrong is when the oversight
governance’ (R1).
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functions fail. That’s got nothing to do with IFRS 10. It’s about bad corporate
It should be remembered that IFRS 10 and IFRS 12 are accounting standards and not substitutes for
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formal regulation. According to several interviewees, the country’s codes on corporate governance (IOD, 2009) and its Company Law (Companies Act, 2008), it is ultimately the responsibility of Boards of Directors and Audit Committees to ensure that financial statements
achieve fair
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presentation. IFRS 10 and IFRS 12 may not be able to address opportunistic behaviour by preparers (Section 5.2.1). At the same time, the principles found in these standards may be circumvented because of legalistic interpretation (Section 5.2.2) and the commercialisation of new means of avoiding the consolidation of SPV’s (Section 5.2.3). Where, however, significant resistance to IFRS 10 and IFRS 12 occurs this may have more to do with poor corporate governance than inherent limitations in the accounting standards. 5.3: The interconnection between isomorphism, legitimacy and resistance According to Rodrigues and Craig (2007, p. 741): ‘a thesis contains an incompleteness that gives rise to an antithesis…A synthesis overcomes the conflict by reconciling the truth contained in the thesis
31
ACCEPTED MANUSCRIPT and antithesis’. In the context of consolidation accounting, coercive, normative and mimetic pressures drive compliance with the new standards explaining why it was difficult to find examples of overt departures from IFRS 10 and IFRS 12. Enclosure of the accounting space is, however, left incomplete and compliance with the new accounting standards is tempered by a logic of resistance. In turn, the interaction between isomorphic pressures and resistance provides a revised thesis for explaining
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developments in accounting practice. This is explained by one respondent as follows:
‘Consolidations came about because of abuse. What do companies do [if they do not want to disclose negative information]? They choose to have special arrangements with their banks so that they can re-arrange their loans to appear on the books of another company
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and the end result is that the external debt of the group appears substantially reduced because it is put into a subsidiary that is not consolidated [because of technicalities]… This detracts from the usefulness of the financials because [they] do not reflect economic
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reality. So we introduce consolidations to better reflect economic substance’ (R11). As discussed in Section 3, however, the concept of ‘control’ per IAS 27 remains narrowly defined, necessitating the release of additional guidance. Although SIC 12 seeks to expand the ambit of consolidation principles (IASB, 2010c), a perceived tension between SIC 12 and IAS 27 has been exploited to exclude structured entities from consolidated financial statements when in the interest of preparers to do so (see Section 3). As these schemes are understood by users and standard setters, they
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are delegitimised and revisions to the IFRS follow to ensure consistent application of consolidation principles. The operationalization of this tension between isomorphic pressures (resulting in conformance with new accounting prescriptions) and logic of resistance is summarised by one
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respondent as follows:
‘We can say that there is a type of arms race between industry and standard setters. As soon as the standard setters find a loophole, they try to close it. And the industry then
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tries to find another loophole… As soon as you introduce the idea of consolidation and people don’t want to consolidate, they find reasons to justify that. IAS 27 requires people to consolidate, but some don’t and so the [standard setters] introduce SIC 12 to clarify what IAS 27 means. But some people still find a basis to avoid consolidation. SIC 12 ends up not being interpreted as the IASB intended and so IFRS 10 is introduced in response. I imagine that it won’t be long before people find creative ways of reading IFRS 10 and we find yet another interpretation being issued’ (R3).
Similar to the findings of Roberts (1985; 2009) what this comment demonstrates is the inherent limitations of mechanisms of accountability and transparency. Far from being a neutral technical process, the development of IFRS is, in part, a product of the continuous interaction between the 32
ACCEPTED MANUSCRIPT theoretical requirements of accounting standards and the actual application of these requirements in dynamic settings. In the context of a logic of resistance, the enclosing properties of IFRS 10 may, paradoxically, lead to new and innovative schemes for circumventing consolidation principles, necessitating a further round of revisions to the IFRS. This may be accentuated when, as discussed in Section 5.4.4, limitations in a company’s systems of governance and internal control leave the
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decision to keep SPV’s off of the balance sheet unchallenged.
6: Conclusion
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This paper adapts DiMaggio and Powell’s (1983) model of isomorphism to demonstrate how coercive, normative and mimetic pressures drive compliance with IFRS 10 and IFRS 12. Interviewees reported that the ‘enclosing style’ of the accounting standards – based on the use of application
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guidance, anti-abuse rules, and illustrative examples – is relevant for ensuring conformance to the revised consolidation principles. Being enacted to improve corporate transparency and accountability, and serve the interests of users, compliance with IFRS 10 and IFRS 12 is also an important means of demonstrating how an organisation’s financial reporting is in line with societal interests. The formal rational structure of the accounting standards; legal backing in some instances; and the taken-forgranted assumption that consolidated financial statements provide useful information to users, adds
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further isomorphic pressure and an incentive to comply with the new accounting prescriptions. The application of IFRS 10 and IFRS 12, however, also gives rise to resistance. Far from being a neutral technical process, the functioning of accounting systems itself produces a dynamic for change and reform as theorised by Hopwood (1987, p. 208).
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More specifically, changes to consolidation techniques are prompted by a misapplication of existing principles in IAS 27 and SIC 12. In particular, the interpretation of the standards to yield two
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different, and potentially conflicting, models of control have led to divergence in practice when determining whether or not an investor has control over its investees. In the context of the financial crisis commencing in 2007, the risk to users of financial statements as a result of unconsolidated structured entities distorting the financial position, performance and cash flows of the respective reporting entities is heightened, necessitating a refinement of consolidation principles. This culminates in the issue of IFRS 10 and IFRS 12 during 2011. These standards should not, however, be interpreted as a comprehensive means of driving improved financial reporting. Similar to the arguments of Cowton and Dopson (2002), Tremblay and Gendron (2011) and Brivot and Gendron (2011), we find examples of resistance to additional prescriptions imposed by the IASB. The complexity of the IFRS, the need for professional judgement, varied commercial contexts and the
33
ACCEPTED MANUSCRIPT underlying self-interests of agents imply that efforts at improving corporate transparency and accountability are tempered by certain preparers. This is made possible by the complexity of contemporary organisations and their consolidation environments, as well as inherent limitations in the corporate governance structures, allowing claims of compliance with IFRS 10 and IFRS 12 to be separated from their actual application.
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Overall, our interviews (irrespective of their areas of specialisation, their age, gender or ethnicity) describe a mutually reinforcing relationship between the introduction of new accounting requirements and the application of these requirements in highly complex social settings characterised by a ‘logic of resistance’. With no practical means of resolving this, the conflict between the IASB (purportedly trying to improve financial statements) and users of the IFRS (in some instances seeking to apply the
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accounting standards to their own ends) is likely to be a defining feature of the next round of changes to the IFRS dealing with consolidation and the principle of control.
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Rodrigues and Craig (2007) suggest that tensions between thesis (accounting as a rational economic system) and anti-thesis (the relevance of socio-political stimuli) shed light on the how global accounting standards may be developing in contemporary capital markets. These findings offer direct evidence in support of this concept of Hegelian dialectic for explaining the progression of financial reporting. They also address the need for context-specific research which sheds light on the operationalization of accounting standards and relevance of institutional theories for understanding
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corporate governance systems (Hopwood, 2000). Although the study only deals with specific IFRS’s, the principles and concepts highlighted by our respondents provide an interesting theoretical framework for illustrating how accounting standards are interpreted and acted upon by human beings. This is especially true given that the consolidation accounting standards are not necessarily more
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relevant for one industry than for another. On the contrary, consolidation principles are widely applied and provide an established case for investigation.
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Nevertheless, future research could expand on our work by applying a similar approach to other significant accounting developments. Most obvious is the proliferation of fair value accounting. While there has been a considerable amount of research examining the development of a fair value measurement basis (Durocher and Gendron, 2014; Zhang and Andrew, 2014) few have considered how resistance to fair value or cost accounting manifests itself in the ways in which preparers of financial statements are applying the relevant IFRS’s. In the same way, it would useful to consider the sources of isomorphic pressure which encourage the proliferation of fair value accounting and how fair value discourse becomes a source of legitimacy. Related to this is the need to understand better social characteristics which influence the relevance of isomorphism and the logic of resistance. With the social construction of accounting paradigms widely accepted (Hopwood, 2000; Rodrigues and Craig, 2007), it is necessary to consider how different 34
ACCEPTED MANUSCRIPT stakeholders interpret and react to the application of IFRS’s. Similarly, this study has not explicitly taken into account the relevance of South Africa’s cultural diversity for the interaction between isomorphic pressure and resistance for shaping changes to accounting standards. Researchers can, therefore, test our assertions by conducting a comparable study in other jurisdictions and considering whether key themes remain constant or vary. As Rodrigues and Craig (2007, p. 755) conclude: ‘It seems likely that more people will consider the process of isomorphism of financial reporting as
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important, while not forgetting the socially constructed nature of accounting and the need for it to adjust to social context’.
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Appendix A: Interview agenda
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The following questions were included in the agenda provided to respondents before the interview (Section 4). Additional probing questions were raised as needed. Although the sequence in which the issues were addressed (and the detail provided by each respondent) varied, the same themes were covered during each interview and the same point was used to commence each interview, namely, the requirement of IFRS 10 to prepare consolidated financial statements.
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1. What do you understand about the requirement to prepare a set of consolidated financial statements? 2. Why do you think the IASB introduced IFRS 10 and IFRS 12? What was the rationale behind introducing them? 3. Do you see any differences or discrepancies between IAS 27 and SIC 12? 4. Does IFRS 10 increase the scope of consolidation? 5. What do you think about the language used in IFRS 10? 6. Does IFRS 10 impact on the way in which you understand control and consolidation? 7. What are the principles contained in IFRS 10 and do you think there are any rules? 8. What do you think about the structure of IFRS 10 and IFRS 12? (This question was specifically for preparers and standard-setters) 9. Do you think that companies are going to comply with IFRS 10 and IFRS 12? What are the main reasons for compliance? 10. Do you think that it is possible for preparers to avoid the preparation of consolidated financial statements? What are the main reasons for this? 11. How relevant are the JSE’s listing requirements and the Companies Act (2008) for the application of IFRS 10 and IFRS 12. 12. What are the main reasons for complying with IFRS 10 and IFRS 12? 13. What do you think are the most common methods used to circumvent the requirements of IFRS 10 and IFRS 12?
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Appendix B: List of interviewees
19
Number
Length on
Cumulative
International
interview
years of
experience in
(approx.)
experience
respective
(approx.)
field
Preparer (multinational)
45 min
17
Yes
Respondent 2
Preparer (multinational)
30 min
17
Yes
Respondent 3
Preparer & academic
60 min
18
No
Respondent 4
Audit partner (assurance)
60 min
15
Yes
Respondent 5
Audit partner (technical)
45 min
16
Yes
Respondent 6
Audit partner (technical)
45 min
16
Yes
Respondent 7
Audit partner (assurance)
45 min
23
Yes
Respondent 8
Audit partner (assurance)
60 min
15
Yes
Respondent 9
Academic
60 min
12
Yes
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Respondent 1
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Background20
SC
Respondent
(financial
accounting) Respondent 10
Preparer (local company)
60 min
13
No
Respondent 11
Preparer
45 min
10
Yes
(former
audit
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manager) Respondent 12
Analyst (financial)
30 min
11
Yes
Respondent 13
Academic
120 min
15
Yes
45 min
18
Yes
(corporate
governance) Regulator
Respondent 15
Preparer (multinational)
60 min
17
Yes
Respondent 16
Retired investment banker
120 min
46
Yes
Respondent 17
Standard-setter
60 min
15
Yes
Respondent 18
Standard-setter
90 min
19
No
Respondent 19
Analyst
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Respondent 14
&
investor
120 min
22
Yes
&
investor
180 min
20
Yes
relations
Respondent 20
Analyst
relations
19
To protect interviewee identities, we did not link the interview excerpts mobilized in the text with the corresponding individuals in this table. 20
‘Preparers’ included financial directors, group financial accountants and senior financial accountants. All preparers are members of at least one professional accounting body.
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ACCEPTED MANUSCRIPT Respondent
Background20
Number19
Length on
Cumulative
International
interview
years of
experience in
(approx.)
experience
respective
(approx.)
field
Investor
45 min
35
Yes
Respondent 22
Preparer (local company)
45 min
20
Yes
Respondent 23
Auditor
30 min
15
Yes
References
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Respondent 21
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