Measuring financial reporting quality: an approach based on qualitative characteristics

I have developed a Financial Reporting Quality (FRQ) measurement index within the scope of the 2018 Conceptual Framework for Financial Reporting of the International Accounting Standards Board (IASB), and I used it to measure FRQ of annual reports from Sri Lankan listed companies. My study is motivated by i) the seminal work of Beest, Braam, within annual reports, both types of decision-makers identified financial statements as the most useful sections and both groups stated that the main factor that restricts the usefulness of annual reports is the delay in publishing annual reports after year-end. When asked directly, both groups challenged the IASB’s current classification of QCs into ‘fundamental’ and ‘enhancing’, and both groups identified understandability as the most important QC, followed by timeliness. Relevance ranked sixth and last, surprisingly. These results complement the findings from RQ1. With respect to the impact of IFRS adoption in Sri Lanka in 2012, both groups believe that FRQ improved compared to the earlier Sri Lanka Accounting Standards (SLAS) reporting regime. In RQ3, I also put in practice the derived FRQ measurement index by assessing the FRQ of annual reports of 53 listed Sri Lankan companies for the years 2010, 2014 and 2018. I find that Sri Lankan companies recorded on average an FRQ of 56% in 2010, rising to 61% in 2014 and to 66% in 2018. These differences are statistically significant, which allows me to conclude that the FRQ of Sri Lankan entities improved after IFRS adoption in 2012 compared to the period before adopting IFRS. This result complements the finding in RQ2. I identified that the total number of pages, the size of the firm as measured by total assets, and her market capitalization all positively correlate with the level of FRQ. Through my work, I have made several useful contributions: I challenge the classification of QCs as fundamental and enhancing, which should also lead to a re- examination of the interpretation various authors of accounting textbooks give to this issue in the corresponding ‘IFRS and Conceptual Framework’ chapters; my results further challenge the widely held assumption that relevance and faithful representation rank supreme in the importance ranking among the 6 QCs; next, I provide numerical equations with which i) users can measure, i.e. calculate, FRQ and the change in FRQ over time, and ii) the IASB can measure to which degree their objective has been achieved of setting standards intended to improve the quality of decision-useful information for investors and lenders. While the processes for the derivation of an FRQ measurement index apply generally, the data have been collected and obtain within the Sri Lankan context. Thus, I invite other researchers to use, test and validate the measurement of FRQ in jurisdictions of their interest.