Academic journal article International Review of Management and Business Research

Hidden Reserves under IFRS - Empirical Insights

Academic journal article International Review of Management and Business Research

Hidden Reserves under IFRS - Empirical Insights

Article excerpt


As globalization progresses, international corporations are under increasing pressure to meet the needs of the international capital markets. One of these requirements is the demand from investors and other stakeholders for reliable financial information which they can use in decision-making processes. Accordingly, corporations should provide high-quality accounting information which is comparable between different entities. Building on this, the International Financial Reporting Standards (IFRS) have been developed to harmonize existing corporate accounting principles and to enhance the informational content of financial reports. However, in practice, the areas of relevance and faithfulness can still cause problems. The measurement of assets and liabilities plays an especially important role in this context.

Keeping this in mind, the question arises as to how useful or rather how faithful and comparable financial statements are under IFRS currently. Many balance sheet items can contain a broad discrepancy between their historical book values and their fair value counterparts. This bias, called hidden reserves, can complicate the comparability of financial reports and might lead to poor relevance and degrade faithful presentation. The use of biased balance sheet figures can even cause bad economic decisions, especially when hidden reserves falsify financial ratios used to evaluate an entity's performance or creditworthiness.

The appearance of hidden reserves is basically caused by two factors. First, IFRS have mandatory rules which can by necessity cause hidden reserves. For instance, it is not permitted to recognize goodwill and certain other intangible assets, and the measurement of assets and liabilities is based on principles which do not permit fair value accounting. Secondly, IFRS give managers a wide range of judgment options concerning the measurement and recognition of balance sheet items. These policy choices can be divided into direct and indirect options. While IFRS offer only a few direct measurement options, e.g. stating property, plant and equipment at fair value instead of historical costs, there are several indirect possibilities for managers to decide whether an item is recognized or not or how it is measured. Consequently, information about hidden reserves must necessarily be considered as they play an important role in the interpretation of financial statements. Accordingly, the purpose of this paper is to reveal the i mpact of hidden reserves relating to different balance sheet figures.

To measure hidden reserves we use disclosed notes to the IFRS 3 - Purchase Price Allocation (PPA). Until 2009, IFRS 3 required a note about the historical book values of the acquired company and their fair value equivalents. Using this information, hidden reserves can be calculated as the difference between these two values. Our data was hand-picked. We scanned about 6,000 financial reports of 1,420 stock-listed European entities, published between 2004 and 2010. In total we gathered a sample comprising 456 PPAs from different industries and countries.

To the best of our knowledge, there is currently no detailed empirical evidence as to what extent hidden reserves exist under IFRS, or rather which balance sheet items are affected more or less by these biases. Therefore, we contribute to the existing literature in showing the currently achieved level of comparability or rather faithful presentation under IFRS. Furthermore, we provide data about the frequency of hidden reserves observed for different countries and industries. Our results show that hidden reserves exist in all balance sheet items, even in positions which are not supposed to contain reserves. We also find fewer hidden reserves than we expected in some positions but higher amounts in other items in contrast. Finally we provide details which give us reason to assume that specific industries and countries tend to state more hidden reserves than others. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed


An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.