Current debatable issue in accounting field is concerning the International
Financial ... Akuntansi Keuangan (PSAK) which a product developed by
Indonesian ...
CHAPTER I INTRODUCTION
1.1
Background
Current debatable issue in accounting field is concerning the International Financial Reporting Standard (IFRS) implementation. IFRS is a universal financial reporting standard developed by International Accounting Standard Board (IASB). The idea behind IFRS creation is to fulfill demand for worldwide standard on financial reporting activities which deemed quite critical in this globalization era. Lesser information barrier along with the increase in access to information, higher volume in global economic transaction such as cross border trading and rising foreign investment activities are the main characteristic of this era. Prior to IFRS implementation, each country has its own local Generally Accepted Accounting Principle (GAAP), this standard was made to serve different type of industries with various business activities that required certain guidance for their financial reporting. Indonesia for example has PSAK as the local GAAP. Other countries are the same, making it more difficult for most of the companies and investors to engage in global transaction and investment. With consideration of the above explanation, IASB is motivated to develop a single set of universal language for financial reporting which intend to increase financial reporting quality and eliminate the discrepancy of financial reporting between countries around the world. Currently there are more than 100 countries which implemented IFRS (Perspectives on the Global Application of IFRS, 2007),
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European Union had started the implementation since 2005, while Indonesia started the implementation process by converging IFRS with the local GAAP (PSAK) in year 2008 and the full convergence is expected to be done in 2012 (Satria, 2010) (The move towards global standards). As mentioned earlier, certain industries require additional guidance for their reporting activities, banking is one of them, and this industry has unique financial structure. Most of its balance sheet’s items either it is assets or liabilities are consist of financial instruments which have active market value. On top of that, banking business plays an important role in the whole economic of particular country because the money is coming in and out through the banking system. Because of this reason banking industry should be well regulated (Sekilas Implementasi Basel II Di Indonesia). Banking industry in Indonesia is supervised under Bank of Indonesia. The financial reporting activities should consider two types of standard such as Pedoman Standar Akuntansi Keuangan (PSAK) which a product developed by Indonesian Accounting Association (DSAK) and Pedoman Akuntansi Perbankan Indonesia (PAPI) which a product developed by Bank of Indonesia incorporated with Indonesian Accounting Association. Regarding IFRS convergence, banking industry has been applying IFRS standard into their reporting activities by referring to PSAK 55, 56 and 60. Those standards are the convergence type of IFRS which is covering financial instrument items such as IAS 32, 39 and IFRS 7. The new PSAK 55, 56 and 60 were defined in year 2006 and the latest PAPI was revised in year 2008 based on PSAK-IFRS Convergence.
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In details, PSAK 50 is the convergence type of IAS 32, Financial Instrument: Presentation, PSAK 55 is related directly to IAS 39, Financial Instrument: Recognition and Measurement, while PSAK 60 is based on IFRS 7 Financial Instrument: Disclosures. Those standards mainly regulate financial instrument items which dominate most of items in banking books as stated previously. Within those standard, fair value is the main subject and lead to several issues in banking industry, such as capital and earnings volatility, debt covenants, capital management, and credit evaluation. In general, the important role of bank is becoming financial intermediaries by obtaining fund from the market and offering loan to the one who need it. Here focuses of the process are the ability to collect the loan from the debtor and granting return to creditor from their savings. Wahlen (1994) stated that the portion of loan portfolio is usually larger compare with its equity and it can be 10 – 15 times larger in amount. Because of this nature it is important to put high concern on this account. According to IFRS specifically IAS 39, loan account will belongs under asset classification “Loans and Receivable” with amortized cost valuation. Like any other items that use amortization cost valuation and directly related to contra-asset account and accrual items in income statement, such as Property Plant and Equipment, Loan account has Loss Provisions as the accrual item and contra-asset account. It is important to consider the amount reported for this provision since it will affect the net book value of the loan. Further, loss provision is used to determine the minimum regulatory capital to be held by specific bank and depict the main inherent risk in banking business, credit risk.
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For most banks, loan provision is the main accrual on their books (Quagli & Ricciardi, 2010) which need management judgment and therefore subject to management discretion (Beattie et al, 1995). Many parties perceive this item as a tool used by management to engage in income smoothing behavior. According to Perez et al (2006) managers are tend to use discretionary items to do income smoothing. Prior to IFRS implementation the amount of loss provisions is determine according to specific percentage for each loan classification. The expected loss from the loan is recognized at the inception of the loan (PWC - IFRS - The Complex Issue Bank Face, 2006). While on the new IFRS implementation the loan loss cannot be recognized at the inception of the loan and it needs objective evidence to trigger the impairment of the loan. Moreover, the loan loss will only depict the loan loss on the balance sheet without any further adjustment to the expected loss. Additionally, as the main accrual in banking income statement, loss provision will directly affect the current reported earnings. Another issue associated with earnings in accounting is the conservatism principle. The concept of conservatism in accounting is recognized loss as soon as it is incurred, while deferred gain recognition until it realized or it also means overvalue expense and liabilities while undervalue assets and revenue. The standard and regulation such as IFRS through IAS 39 that prohibit the recognition of loss provisions on the inception of the loan and to recognized any expected loss will then influence conservatism principle in banks’ earnings.
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1.2
Research Question
Does IFRS convergence give impact on loan loss provisions and increase bank’s reporting quality by reducing the income smoothing behavior?
1.3
Scope
This paper will focus on Indonesian banking industry during 2008 – 2009 (pre-IFRS convergence) and 2010 – 2011 (post-IFRS convergence). These years are chosen because preferably best representing the condition of pre and post IFRS convergence in Indonesia. The data are collected from all listed banks in Indonesia Stock Exchange starting from year 2008 or prior and still keep their present until now.
1.4
Aims and Benefits
The aim of this research is to identify whether or not the IFRS convergence give impact on loan loss provisions and increase financial reporting quality by reducing income smoothing behavior in Indonesian banking industry. The main concern is the recognition of loan loss provision using the new standard which limits the management discretion in determining the level of loss provisions for the current year. The amount of loss provision will affect the income reported for the existing year. Finally this research will give benefit for those who have concerns in banking industry such as:
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a. Independent Investor This research is useful to remind the investor about the most important item in the banking book and its significance to the whole banking business performance. Hopefully this information will make them become more conscious about the effect of existing financial reporting standard to the bank financial report which later used to determine their investment strategies. b. Standard Setter (Dewan Standar Akuntansi Keuangan) Standard setter will get additional information regarding the impact of IFRS convergence in banking industry, the information can be useful in considering further standard to be implemented. c. Government body (including Bank of Indonesia) The result obtained from this research will be beneficial for government body in determining appropriate regulation concerning specific business sector. Bank of Indonesia in specific can use the result as consideration to decide appropriate level of Capital Adequacy Ratio which mainly derived from bank’s credit risk through loss provisions and non performing loans reported, here banks are required to keep certain amount for their capital. d. Accountant Profession and Academicians The information from this research will give additional knowledge either to accounting profession or the academicians especially in banking industry. It will provide insight about the banking industry business process and certain related accounting treatment in banking.
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e. Management in banking industry This research will encourage management to maintain the quality of their accounting information while also provide information about the effect of IFRS convergence on their reporting activities.
1.5
Research Methodology
This paper will use quantitative research method approach with multiple regression analysis to determine the effect of IFRS convergence in diminishing income smoothing activities as well as its effect to the banks’ earnings conservatism. The model developed by Gebhart and Farkas (2010) for similar study in European Countries will be used to prove the impact of IFRS convergence in Indonesian banking industry. Further detail regarding this research methodology will be described in following chapter.
1.6
Research Structure
The general structure of this paper will be reviewed as follow: Chapter 1 – Introduction, This chapter will explain the background problem that leads the writer comes up with the research questions. Following by broad research scope, research methodology and gives a clear benefits of this research.
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Chapter 2 – Theoretical Framework There will be all essential theories regarding the effect of IFRS implementation in banking industry such as, specific standard for Indonesian banking industry, details about loan account in banking book, its recognition and measurement as well as its disclosures and presentation prior and post IFRS implementation, the main challenge in implementing new standard, earnings management behavior, and other related theories. Finally, the conservatism issue in regards of banks reported earnings and the hypothesis development process for this research. Chapter 3 – Research Methodology This chapter will explain in details how to choose the data, the sampling and collection method. Moreover, there will be techniques and model used in data analysis. And finally the software used for further data analysis. Chapter 4 – Findings and Discussions This section will present the empirical findings followed by thorough discussion of it. Finally, whether or not based on the findings to accept or reject the hypothesis. Chapter 5 – Conclusion and Recommendation Here there will be a summary of the entire research. The main contents are pointing out the most importance findings and recommendation for further research.
