IFRS Is Coming to Africa. Beware!

By: Solomon George Zori

The Author is a Doctoral Fellow in the area of Accounting and Taxation at the Max Planck Institute for the Study of Societies, University of Cologne, Germany

The strong seek to converge while the weak adopt. I pose the question, why should Africa (not) adopt IFRSs?

In the past decade the rise in the use of the use of the so-called International Financial Reporting Standards (IFRS) in many countries around the world has moved the wave towards developing countries considering adopting these standards. Factually, about 120 countries presently use IFRS across the globe. Out of this number about 13 countries in Africa have already adopted (i.e as issued by the IASB without any modification) or adapted (i.e. with modification to meet local socio-economic needs of a particular accounting jurisdiction) to IFRS. See map below for geographical split of IFRS jurisdictions in Africa.

However, it is quite surprising that Africa as a whole is considering adopting IFRS given the chaotic nature of these standards on the international front and the often unseen justification given for the adoption of IFRS particularly in Africa. Many international organizations like the World Bank the World Trade Organization, USAID and UNCTAD have all been arguing for the adoption of IFRS in less developed countries. There are many reasons why Africa should not adopt IFRS. I will try to explain and to some extent justify the inappropriateness of IFRSs in less developed countries in particular reference to Africa.

Politics over Economics

First, the merits of IFRS often mentioned include, improved comparability and uniformity of financial statements among companies and countries, resulting in a decrease in the equity cost of capital, improved transparency in financial reporting, a decline in information processing costs and a reduction in risk of international investment decisions amongst others. Whilst these benefits look very desirable, it is also the case that these benefits cannot be reached in every economy. A country’s accounting system cannot stand alone. It must be supported by a strong institutional foundation. Institutions shape accounting and not the other way around. In other words, IFRS in a weak institutional framework or at least in an institutional framework which was not originally designed for IFRS is as good as any other accounting standard claimed to be inferior to IFRS.

To be clear, IFRSs were designed for developed and matured capital markets. At least the economics speaks for itself. It is an undeniable fact that financial statements assist investors in making critical investment decisions. As pointed out in the general purpose of financial statements in the conceptual framework of the IASB, financial statements should aid users in valuing securities, be it when buying or when selling-thus a valuation function.

The argument for the use of IFRSs in developed countries in plausible. However, what I find puzzling is the push for IFRS adoption even in countries that have no stock markets or stock market listed companies. I do not deny that quality financial reporting should be present in economies where there are no capital markets. But I also admit that such countries have totally different financial reporting needs than industrialized countries. As mentioned earlier, accounting system of a country is traditionally shaped by its socio- economic, cultural and political environment. Some economies are totally different from others and therefore we must recognize that these differences in accounting needs shape financial reporting. This brings me to the conclusion that, a country’s decision to adopt IFRS is a sacrifice of economics for politics. Many researchers uphold this view in both political science and accounting literature.

The Strong converge while the weak adopt

What is even more intriguing is the fact that the highly industrialized countries have all, to some extent, cherry picked some parts of IFRSs, i.e. converged to IFRS on their own terms, whilst urging less developed countries to adopt unreservedly without any modification. For example, we might think that the larger economies like Canada, the European Union, China, India, Russia, and Japan have all adopted IFRS. Nearly all these countries have modified IFRS to suit their economic needs. In other words, they pick and choose which IFRSs are relevant and which are not. Unfortunately, many developing countries are in the terrain of adopting these standards without any thought to modification, for example, South Africa, Ghana, Nigeria and many Southern African countries.

Accounting for double standards

Second, proponents of IFRS argue that once a country is developing rapidly, there is the need for a sound financial system to complement and consolidate this development process. Thus, it is a well-established argument that many African countries are experiencing huge economic growth and an increase in Foreign Direct Investments and therefore, to attract foreign investors, there is the need for a more transparent financial accounting system like IFRS in addition to general capital market liberalization.

However, many accounting scholars have documented that the decision of an investor to invest in a particular country is actually independent of the financial accounting system of that country. In fact, it is the reverse that holds true. Countries that already have a sound accounting system together with strong investor protection laws are unlikely to adopt IFRSs. I argue that IFRSs are only adopted by countries where there is a weak financial regulatory system. The economic growth justification for the adoption of IFRS is further flawed in that, at the time these highly industrialized countries were developing, the accounting standards in place were fundamentally different from IFRS.

We may even consider whether, at the current stage of development in Africa, IFRS are not a solution at all, but rather possess real threats - A point I shall return to. A recent publication by the South African Institute of Chartered Accountants claimed that the IMF and UN have all projected Africa to grow in GDP terms by 5% in 2011; hence adopting IFRS is the only way forward. The report further iterated that for Africa to progress it is vital that the continent speak “one financial reporting language”.

I view this as having some amount of truth. However, speaking one financial language will not solve the many problems of unenforceability of regulation in Africa – enforceability of accounting standards is key. It does not also eliminate the question whether a complete adoption of IFRS will be more beneficial than IFRSs with modification.

I pause here to question; why is it that the larger economies are not adopting IFRSs as issued by the International Accounting Standards Board (IASB)? The world of accounting standards is clearly ruled by double standards. For example, the United States of America is taking too much time to reach a final decision if even at all US companies should adopt IFRS. Even then, their decision is not to consider a complete adoption of IFRS, but to seek to converge with IFRS. The same is true for China, India, Japan, Australia, New Zealand, Canada and Russia. And yet, it is often the case that African countries adopt IFRSs as given. For most of these highly developed countries, the fear of losing sovereignty in the setting of accounting standards makes it difficult to adopt IFRSs. Adopting IFRS as given means that individual countries can no longer influence the outcome of these standards. With many new world powers emerging now, for example China, it will be difficult for countries which previously dominated accounting standard setting scenes to singularly determine accounting choices and alternatives. Unfortunately, in the context of Africa, adopting IFRSs means, following the rule but not taking part in the rule making.

What is good for the goose is good for the gander. Designing accounting standards that you have no intentions of following fully should not be passed down to others to apply.

Uniformity for a diverse continent?

A third argument I would like to advance for the non-suitability of IFRS in Africa is the fact there is to a larger extent a greater diversity in the socio-economic setting in the continent. At least in the European Union (which happens to be the largest patron of IFRS), there exist differences between member countries. But one thing sets them different from the African Continent. The ability of the European Union to design regulations and directives that are enforceable by all member states makes it easier to have a uniform financial system. In Africa, even regional bodies such as ECOWAS and the AU are hardly able to agree on anything which can be enforced.

At a conference in South Africa, the outgone chairman of the IASB, Sir David Tweedie, commented that the process of designing IFRSs involves constituents from around the globe. These continents speak with one voice and have the backing of the representatives from the Institutes and Standard Setting Boards within the countries on those continents. When they speak, IFAC (the International Federation of Accountants) and the IASB have to listen. These other continents (excluding Africa) influence the development of the Standards to take care of circumstances within their continents. Africa is also there, but because its countries of this very diverse continent – 54 states! – do not have a united voice, they generally have minimal influence. It is no surprise that on the board of Trustees, Africa is represented by only one member out of 22 whereas America has 5, Asia has 6 and Europe has 5 on the board. Even then, by the mention of Africa, accounting standard setters refer to South Africa and not the rest of underdeveloped Africa.

Even if African countries should adopt IFRS as given, it is unclear how the benefits of IFRS can be measured, as enforcement within the region will be left in the hands of individual countries. Apart from that, each country in Africa differs from the others economically. Thus, whilst some countries are clearly natural resources driven, some countries are only tax based economies. That is, whereas some countries are highly dominated by the public sector, other countries largely depend on the private sector. This makes their informational needs differ from each other and therefore putting IFRS in such economies will still not yield the desired goal of comparability of financial statements.

Fairer valuation thanks to Fair Value?

Fourthly, during the just ended painful financial crisis, it was often held that the IFRSs were the catalyst that galvanized the crisis. Thus- the so-called fair value accounting beast! Whether IFRS was just the messenger, as often argued, or the fuel that fed the crisis, somehow IFRS was part of the problem.

Even, as I write, there are huge problems in countries that currently apply IFRSs. Take Greece and Portugal for a case. How valuable is the use of IFRS in such economies? Can we claim to have the same level of market efficiency in fair value terms in these countries? Now compare IFRS in Greece to that of a country that has not stock market let alone, an efficient and stable economy, like Somalia, Togo, Chad, Benin and many other under developed countries. How differently do investors view IFRS statements from Greece as opposed to the UK? This is open to different interpretations.

A recent report by the IMF indicated that Africa`s resilience through the global financial crisis owes much to sound economic policy, citing steady growth, low inflation, sustainable fiscal balances, rising foreign exchange reserves, and declining government debt. I argue that, if IFRSs were part of the problem and that the G20, the EU and individual governments managed to avert the situation

via bail out packages, how would Africa have responded to the crisis? I leave this point open for readers to think about and to send me comments, if they so wish.

For small players, cost is the bigger issue

As accountants and users of financial statements, the concept of costs versus benefit analysis is nothing new to us. The idea of a switch to IFRS can be viewed in two cost dimensions. The first is that accounting standards are costly to design, let alone implement. That explains why most less developed countries may just fall upon already developed standards from industrialized countries; for example, Indonesia adopting US-GAAP and Ghana adopting IFRS. The second dimension is that the implementation of some of these standards could be very costly to firms and impose resulting costs on the adopting country.

The real benefits of IFRS are hard to quantify in monetary terms, but it may be easier to gauge the costs of implementation. Proponents of IFRS argue that, by adopting IFRS, an entity is likely to reduce its cost of capital. Unfortunately, there is simply no hard evidence that cost of capital reduces upon adopting IFRS. Unless a country has a well-developed stock market with equity participants willing to pay a premium for high quality financial reporting, the costs of IFRS implementation far exceed the benefits. As stated in an interview with the Christian D. Migan, president of the OHADA (the Organisation pour H´Hamonisation en Afrique du Droit des Affairs) he puts it bluntly,’’who will pay for the cost of implementation of IFRS in a countries such as Chad, Benin, Togo, Burkina Faso and all the OHADA regional countries which has no capital markets and nearly 80% of the companies as small scale entities?

Big four audit firms are happy, but clients are moaning in pain

The idea of adopting IFRSs is seen to be driven by the big four audit firms. Literature documents their strong involvement in the development of IFRSs. The real issue in the case of Africa is that, we lack the expertise to foster the smooth transition to IFRS. What it means therefore is to hire the services of the big four audit firms. They like change. Change that clients have no idea to handle- for example financial instruments and accounting for off balance sheet transactions. Capitalizing on this and making money at the expense of clients is my view very inappropriate. Why can’t we see that auditors are happy to advocate for IFRS? They stand to gain in every way.

It is time for Africa to pause and take a serious look at the possibilities of an accounting system that better reflects the needs of the continent and its individual countries. The question is; is Africa ready for IFRS? as opposed to is IFRS ready for Africa?

The Author is currently a Doctoral Fellow in the area of International and Transnational Accounting Standard Setting at the Max Planck Institute for the Study of Societies-Germany. Comments should be emailed to solomon.zori@accamail.com