Drivers of Hidden Reserves - Consequences for the Comparability of Financial Statements under IFRS

IntroductionThe faithfulness and comparability of financial statements is frequently discussed in literature. In this context, there are many different points of views examining the topic of comparability in particular. While some researchers focus on differences in the application of IFRS accounting principles between countries (e.g. Cole, Branson, & Breesch, 2013; Kvaal, & Nobes, 2012 or Ball, 2006), others look for differences between industries (e.g. Jafaar, &McLeay, 2007) or size (e.g. Nobes, & Perramon, 2013). There are also discussions about the usage of fair value accounting vs. historical cost accounting in IFRS and if one of these approaches is superior to provide comparable financial statements (e.g. Penman, 2007). Without doubt, all these studies give useful insights to the comparability of the application of IFRS accounting principles. Nevertheless, these studies have also in common that they do not show the quantitative degree of comparability or rather incomparability. To be more precise, they do not measure the consequences of incomparable balance sheet figures under IFRS. A possible measure of comparability in this context would be the hidden reserves contained in financial statements. Hidden reserves can be defined as the discrepancy between the historical book values of balance sheet items and their fair value counterparts. This discrepancy can be caused by different reasons - like accounting choices or judgement options managers have by applying IFRS (e.g. stating property, plant and equipment at historical costs instead of fair value or determining the probable amount of provisions). In consequence, this means that a perfect comparability of financial statements could only be accomplished if hidden reserves did not exist.In a study of Brahler and Schmidt (2014), hidden reserves under IFRS are empirically measured for the first time in detail. The paper describes the total amounts and the frequency of hidden reserves observed in financial statements. The study provides data for different countries and industries and shows that hidden reserves can reach high amounts and occur frequently. However, the results are presented only in a descriptive manner without any further explanation of the factors which can be seen as drivers of hidden reserves. Accordingly, it is not possible to differentiate if some countries or industries show significant higher amounts of hidden reserves than others.The purpose of this paper is to fill this gap and link the aforementioned hidden-reserves-data to other related research in this field. If factors like country of origin, industry membership and size of an entity influence the application of IFRS accounting principles, then we must assume that these factors have also an impact on the probability that a company holds hidden reserves. Therefore, we use the descriptive data of Brahler and Schmidt (2014) to identify potential drivers of hidden reserves by performing a logistic regression. As a result, our investigation will provide additional empirical evidence if comparability under IFRS is achieved and which determinants indicate the existence of hidden reserves in the case of a specific entity.The remainder of this paper is organized as follows: Related literature is reviewed in the next section. Section 3 provides background information on the data we used and contains some preliminary considerations to our research design. We formulate our hypotheses in section 4 and describe our methodology for testing them in section 5. Our findings and results are outlined in section 6. At last, Section 7 contains our conclusions.Literature ReviewOur study is basically related to research in the fields of hidden reserves and the comparability of financial statements under IFRS.In this context, most examinations deal directly with the comparability of financial reports or indirectly with the harmonization process of accounting practices under IFRS. …