Earnings Quality and Value Relevance of Earnings A Comparison between Pre and Post IFRS Periods in Sri Lankan Context

Abstract

The introduction of IFRS as a response to the extensive necessity of a common language for financial reporting has opened up new paths for a major line of research area, as the extent of the achievement of the objectives attached with the implementation of IFRS is open to debate all over the world despite its widespread adoption. Accordingly, this study aims to examine the impact on earnings quality and value relevance of earnings on the convergence with IFRS by Sri Lanka by following the global trend of harmonisation of financial reporting practices. The study assesses whether the earnings management practices are significantly low resulting in a higher earnings quality with the adoption of IFRS and whether the value relevance of earnings is significantly higher in the post IFRS period than pre IFRS period with respect to the companies listed in the Colombo Stock Exchange (CSE). The study covers two time periods; three years’ period before (pre) and three years’ period after (post) the adoption of IFRS. The study employs Dechow et al. (1995) and Kasznik (1999) models to measure the abnormal accruals in order to evaluate the quality of the earnings through earnings management practices. The study then follows the theoretical frameworks of price earnings model and return earnings model as proposed by Ohlson (1995) and Easton and Harris (1991) respectively to assess the value relevance of earnings.The results of the study indicate that the level of earnings management is increased in the post IFRS period indicating a lower level of earnings quality with the adoption of high quality standards of IFRS. Further it finds that the value relevance of earnings is reduced in the post IFRS period than pre IFRS period. The results of the study contribute to fill the existing gap in the literature with respect to the adoption of IFRS by developing countries and frontier markets on the earnings quality and value relevance.The results of the study provide additional evidence to the debate among the researchers on the existence of other significant variables which help to improve the quality of the financial information at individual country level.