The effect of changes in the accounting for loan loss provisions on managers' decisions

Abstract

This study provides evidence of the effect of the change in the accounting for loan loss provisions from allowing low levels of professional judgement, to a new standard that permits managerial judgement and discretion in the measurement and application of loan loss provisions. The International Financial Reporting Standard (IFRS) 9 introduces an ‘expected credit loss’ model that takes into account reasonable and supportable forward-looking information. Under IFRS 9 it is no longer necessary to have ‘objective evidence’ of impairment before a provision is recognised as was the requirement of the International Accounting Standard (IAS) 39. The change to greater discretion in measuring loan loss provisions makes this event particularly useful to examine the impact of accounting standards that allow more judgement and discretion on managerial behaviour. I used an experiment to examine whether the expected credit loss model of IFRS 9 leads to an increase in earnings management compared to the incurred credit loss model of IAS 39. Using a banking environment setting, the experiment manipulated the presence versus absence of earnings management incentives and IFRS 9 versus IAS 39 accounting standard. I contributed to the literature by demonstrating that the change from IAS 39 to IFRS 9 achieved the objective of allowing more managerial discretion without causing increased earnings management.