Pacific Accounting Review

The readability impact of international financial reporting standards

Glenn Richards Chris van Staden

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Glenn Richards Chris van Staden , (2015)," The readability impact of international financial reporting
standards ", Pacific Accounting Review, Vol. 27 Iss 3 pp. 282 - 303
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PAR
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The readability impact of

international financial reporting
standards

282

Glenn Richards
Staples Rodway, Auckland, New Zealand, and

Chris van Staden

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Department of Accounting, Auckland University of Technology,

Auckland, New Zealand
Abstract
Purpose This paper aims to compare the readability of narrative annual report disclosure pre- and
post-International Financial Reporting Standards (IFRS) adoption using a computational linguistics
programme to determine if annual report disclosures have become more difficult or easier to read
following the adoption of IFRS.
Design/methodology/approach This paper empirically measures narrative annual report
disclosure readability pre- and post-IFRS adoption using a computational linguistics programme. In
this analysis, the authors control for variables that have been identified as relevant to the understanding
of financial disclosures, such as size, business volatility, financial leverage and industry.
Findings Significant relationships have been identified between IFRS adoption and reduced
readability indicators using readability formulas, and also using other factors such as increased length
of annual report disclosures and increased use of tables. Findings suggest that the adoption of IFRS has
added complexity and resulted in reduced readability of annual report disclosures.
Practical implications Academic backing to claims of IFRSs negative implications for financial
statements and their ultimate users should encourage action on the part of standard setters and report
preparers to address the negative impacts of IFRS adoption.
Originality/value This paper is the first to provide evidence that New Zealand equivalents to IFRS
adoption have resulted in not only longer disclosures but also more complicated disclosures.
Keywords Readability and IFRS adoption, Readability of narrative annual report disclosure
Paper type Research paper

1. Introduction
Late in 2009, a London-based periodical published an interesting yet troubling article
suggesting that:
Companies have given up trying to make their annual reports readable according to
PricewaterhouseCoopers reporting chief who believes over-regulation could be killing off
good reporting. David Phillips, PwCs senior corporate reporting partner, believes a box

Pacific Accounting Review

Vol. 27 No. 3, 2015
pp. 282-303
Emerald Group Publishing Limited
0114-0582
DOI 10.1108/PAR-08-2013-0086

The authors would like to thank participants at the Accounting and Finance Association of
Australia and New Zealands 2011 Conference in Darwin and participants at research seminar
presentations at Deakin University, Cardiff University, and the Universitt of Regensburg for
their useful comments. The authors also thank Professors Mike Bradbury and David Lont for
their feedback on this paper.

Downloaded by Xiamen University At 13:14 17 December 2016 (PT)

ticking culture has degraded annual reports to the point where they are, legally compliant,
but, as a communication document, dreadful he said. What the investors want is just good
data and, if Im honest, financial reporting today doesnt give them that (Christodoulou, 2009,
p. 1).

This observation is interesting in light of increasing international support for

International Financial Reporting Standards (IFRS), and raises the question: has IFRS
degraded annual report readability or improved it?
We investigate the implications of the implementation of IFRS on the readability of
annual report financial disclosures. More specifically, we investigate whether narrative
annual report disclosures have become more difficult, or easier, to read, following the
adoption of IFRS. We propose that more complicated (difficult to read) annual reports
point to a lower quality of disclosure (as shareholders, investors and other users will face
increased cost and time to process the information contained in the annual reports) and
readability can therefore be regarded as a disclosure quality measure (Li, 2008). We use
the New Zealand equivalents to International Financial Reporting Standards (NZIFRS)
in our analysis. New Zealand has adopted IFRS and is therefore a useful place to
examine this issue. While New Zealand is the context of the research, the results could be
applicable to other jurisdictions adopting IFRS, in that the readability of narrative
disclosures could have been affected wherever IFRS is adopted[1]. The findings could
therefore be of broad interest.
Readability formulas and the analysis of written documents have strong roots within
academia. In 1948, Rudolph Flesch introduced one of the most common methods, the
Flesch Reading Ease (Flesch) formula, with his paper A New Readability Yardstick
(Flesch, 1948). Just two years later, this method was incorporated into the accounting
environment to investigate the readability of corporate annual reports (Pashalian and
Crissy, 1950). Today, the Flesch score, the FleschKincaid, the DaleChall formula and
the Fog formula are common examples of analytical tools used for the assessment of
readability characteristics in accounting documents. We empirically measure narrative
annual report financial disclosure readability using readability measures extracted
from a computational linguistics programme (Readability Calculations, by Micro Power
& Light Co.) based on syntactical textual features (such as words per sentence and
syllables per word).
We posit that the adoption of IFRS has led to more tedious and complex annual report
narrative disclosures. We present the hypothesis that the added and complex IFRS
disclosure requirements have resulted in deteriorated readability, and therefore, lower
disclosure quality, of what are already complex and criticised annual reports
(Bebbington and Song, 2003; Courtis, 1986; Schroeder and Gibson, 1990; Worthington,
1978). This presents an interesting situation given the significance of corporate
disclosures to stakeholders who rely on these when forming decisions. Such a
relationship would suggest that, while IFRS is often cited as furthering international
harmonisation and a step towards higher-quality standards, it may lead to lower-quality
disclosures and may reduce the usefulness for end users, should their ability to read and
understand annual reports significantly deteriorate as a result.
Although the readability of annual reports has been researched in the past (Li, 2008;
Schroeder and Gibson, 1990), we contribute to this literature by being the first to provide
evidence that the adoption of IFRS has resulted in disclosures that are longer and less
readable and therefore more complicated. Our findings highlight the complexity (in

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terms of readability ease) of the narrative disclosures required by IFRS and show that
readability has decreased, rather than improved.
The remainder of this paper is structured as follows. A review of the literature
surrounding IFRS and readability analysis is presented in the next section, followed by
the hypothesis development and research methods. This is followed by our findings
with additional tests, including robustness and sensitivity tests. The paper ends with a
discussion and conclusions, including limitations and suggestions for future research.
2. Literature review
2.1 International financial reporting standards
IFRS are developed by the International Accounting Standards Board (IASB). Their
objective is to develop a single set of high quality, understandable, enforceable and
globally accepted financial reporting standards based upon clearly articulated
accounting principles (IASB, 2010a, p. 2). The need for such standards has arisen due to
the evolution of global economies, cross-border investment/borrowing and increasing
emphasis on international harmonisation (Mogul, 2003). More than 100 countries have
endorsed IFRS, by requiring or allowing its use (IASB, 2010b)[2]. Although there are
areas where work is still required (Fleck and Ceams, 2008), the IASB is making strong
and steady progress. The Accounting Standards Board of Japan has announced support
with the Tokyo Agreement in 2007 (Kaneko and Tarca, 2008) and commentators have
noted from a recent G20 summit:
[] [the G20] reaffirmed their commitment to global convergence in accounting standards,
calling on international accounting bodies to redouble their efforts to achieve a single set of
high-quality, global accounting standards within the context of their independent
standard-setting process, and complete their convergence project by June 2011 [] (Global
convergence of IFRS, 2010, p. 1).

In 2002, the Accounting Standards Review Board (ASRB) announced that New Zealand
reporting entities would be required to apply IFRS for the preparation of external
financial reports. This was to take effect for all periods commencing on or after 1
January 2007, with provisions to allow for early adoption commencing on or after 1
January 2005 (Hart and Rainsbury, 2006). The decision to adopt IFRS stemmed from the
decisions of the European Union and, consequently, Australia, to adopt IFRS
(Bebbington and Song, 2003). Since that announcement, the Financial Reporting
Standards Board (FRSB) has developed complete NZIFRS[3]. These were successfully
submitted and approved by the ASRB in 2004. Bradbury and Van Zijl (2005, p. 79) noted
that generally NZIFRS diverge from the original IFRS in regards to:
[] contain[ing] additional disclosure requirements and/or eliminate [some] optional
treatments. They may also contain additional requirements on measurement and recognition
but such requirements, if any, apply only to public benefit entities.

A commonly cited reason for some of the amendments was to allow sector neutrality[4]
to continue within New Zealand, similar to the pre-existing New Zealand Financial
Reporting Standards (NZFRS) or to account for the unique New Zealand business
environment.
Research on the adoption of NZIFRS within New Zealand has been limited, focussing
on NZIFRS and its potential financial impacts only (Bradbury and Van Zijl, 2005;
Kwong et al., 2005; Hart and Rainsbury, 2006; Boult and Wee, 2006; Lee and Teixeira,

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2004). Kwong et al. (2005) attempted to assess the impact of NZIFRS on companies
within the NZX50. They were unable to quantify what the actual impact of NZIFRS
would be. However, they were able to identify specific entity types that would be
susceptible and the likely financial areas that would have the greatest implications, such
as agricultural activities, revaluations, deferred tax, intangible assets and goodwill
(Kwong et al., 2005). Bebbington and Song (2003) commented that, comparatively, IFRS
and the traditional NZFRS are notably similar when compared to IFRS and the
standards of some European Union countries and, as such, minimal implications should
result from the ultimate adoption of NZIFRS. However, they report, similar to Kwong
et al. (2005) and Bradbury and Van Zijl (2005), that some specific areas are notably
different. Hart and Rainsbury (2006) provide some quantifiable evidence of the impact
on early adopters of NZIFRS. Their data indicate increases of up to 7.15 per cent in total
liabilities, with a related 6.96 per cent decrease in total equity. Profit after tax and EBIT
increased by 5.14 and 2.86 per cent, respectively.
2.2 Readability analysis
Dale and Chall (1949, p. 23) present readability as:
In the broadest sense, readability is the sum total (including the interactions) of all those
elements within a given piece of printed material that affect the success a group of readers have
with it. The success is the extent to which they understand it, read it at an optimum speed, and
find it interesting.

Many factors should be considered when analysing written material for ease of
understanding, and a variety of techniques have developed that attempt to predict
readability. The most common approach is the use of readability formulas, which have
been widely used since the 1950s. Readability formulas are mathematical equations
derived by regression analysis, in which a model or equation is constructed that best
predicts the reading grade level of readers who comprehend a given text. In their
construction, comprehension is assessed by a specific pass score on test questions based
on the content of the text. (Mandic et al., 2012). Chavkin (1997) noted that the two
strongest and most common elements used in analysing written material for ease of
understanding are vocabulary difficulty and sentence length. Indeed, it is variations in
these two elements that make up the majority of readability formulas. Stevens et al.
(1992) supports this, noting readability formulas determine the readability level of a
passage by examining word difficulty and sentence length (Stevens et al., 1992, p. 1).
While more than 30 readability formulas exist to assess the readability of text
(Meyer, 2003), some are favoured by researchers and commentators. These include the
DaleChall formula, the Flesch formula, the FleschKincaid formula, the Fog formula
and the Cloze procedure (Courtis, 1986; Flory et al., 1992; Stevens et al., 1992; Schroeder
and Gibson, 1990; Lehavy et al., 2009; Worthington, 1978). Readability formulas have
grown in popularity because, unlike comprehension tests or subjective scoring
techniques, no reader participation is necessary (Subramanian et al., 1993). This can
lessen any potential validity threats resulting from selection and makes replication
possible. Furthermore, readability formulas capture the characteristics rather than the
content of the disclosure (Li, 2008).

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2.3 Readability analysis and accounting

Readability formulas have a strong academic foundation within accounting.
Readability studies have typically focused on elements of companies annual reports,
specifically the management discussion sections and the financial statement notes
(Courtis, 1986; Lehavy et al., 2009; Flory et al., 1992; Schroeder and Gibson, 1990;
Worthington, 1978; Pashalian and Crissy, 1950). Flory et al. (1992) noted that, while
some studies have used the Cloze procedure, most have adopted the Flesch formula[5].
Readability of annual reports is a topical area. These documents represent the
primary source of information for investors and analysts for decision-making purposes.
As such, it is important that users are able to understand and comprehend the
information contained within a companys annual report. However, the US Securities
and Exchange Commission and the media criticise the complexity of company reports
and communications (Lehavy et al., 2009).
Unsurprisingly, given the significance of corporate disclosures to regulators and
investors, numerous papers have been published that investigate the readability of
annual report disclosures. In one of the first papers to apply the Flesch formula in an
accounting environment, Pashalian and Crissy (1950) investigated the readability of
corporate annual reports and found that the general level of readability observed was
difficult, and beyond the comprehension of 75 per cent of the US adult population.
Courtis (1986) utilised the Flesch and Fog formulas in 142 Canadian annual reports
covering the period 1982-1983. His data supported the conclusion that readability ease
was between difficult to very difficult. He went further and found that footnotes may be
beyond the comprehension of 92 per cent of the Canadian population and that
readability was associated with the risk facing the company (Courtis, 1986).
Worthington (1978) applied the DaleChall readability formula to a sample of the second
largest 500 industrial corporations, using Fortunes 1974 ranking. His findings showed
that financial disclosure readability ranged from difficult to very difficult. Schroeder
and Gibson (1990) reviewed early research into financial disclosures, including papers
from 1950 through to 1980. Based on this historical research, they concluded that
footnote readability was poor (Schroeder and Gibson, 1990).
More recently, Li (2008) used the Fog formula and added document length as another
proxy for readability. She concludes that annual report readability of poorly performing
firms is lower than that of well-performing firms. Dempsey et al. (2012) examined the
pricing implications of firm disclosure opacity, measured by the readability of Real
Estate Investment Trusts annual reports. They found, consistent with previous studies,
that annual report complexity was significantly greater for poorer performing firms.
Bayerlein and Davidson (2012) investigated the effect of connotation on readability and
obfuscation. They found the reading difficulty levels within chairman addresses were
typically high, or very high[6].
While it is our opinion that the use of readability formulas in accounting is valuable
and has stood the test of time, there is some debate over the general applicability of
readability formulas in the accounting context (Stevens et al., 1992). General criticism
regarding readability formulas has focused on the imperfect match of readability and
understandability. The assessment of readability, using readability formulas, focuses
on the analysis of syntactical difficulty, whilst understandability should consider a
wider range of determinants (Bayerlein and Davidson, 2012; Hewaidy, 2007). Such
determinants include jargon, concept difficulty, concept density and visual aids.

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Furthermore, readability formulas are unable to assess the level to which an individual
readers level of interest, knowledge, education and experience influences
understandability (Bayerlein and Davidson, 2012). Technical documents may therefore
be easier to read for readers who possess a specialized vocabulary and knowledge base
that is not held by the average reader (Sydserff and Weetman, 1999). Readability
formulas use the average reader to calculate the level of difficulty involved in reading
a piece of writing.
We do not set out to calculate the absolute level of reading difficulty for the financial
reports (and we do not report on that). Rather, we want to determine if the level of
difficulty has increased following the adoption of IFRS. While we accept that technical
material could produce unduly inflated difficulty levels, we rely on Flory et al. (1992)
who suggest that this is only an issue if the researcher attempts to determine an absolute
reading level, i.e. when one seeks to provide a definitive grade level required for
comprehending a piece of writing. When used solely for comparative purposes between
equally technical documents, such as yearly comparisons of annual reports, the issues
raised as criticism above pose no material limitations. Furthermore, readability
formulas have the benefit of being reliable and comparable when calculated across time.
3. Method
3.1 Hypothesis
As indicated, we want to answer the following question: have narrative annual report
disclosures become more difficult, or easier to read, following the adoption of IFRS? To
this end, we focus on the complexity of narrative company financial disclosures, as
measured by their readability rather than their content. To test for a relationship
between NZIFRS adoption and financial disclosure readability, the following
hypothesis is investigated:
H1. There is a significant correlation between IFRS adoption and the level of
difficulty of the readability of annual report financial disclosures.
We compare readability pre- and post-IFRS adoption in New Zealand (NZIFRS).
However, NZIFRS allowed for early adoption, which has led to varying adoption dates
for NZX50 companies. Therefore, we analyse data for the three years preceding NZIFRS
adoption and for two years following adoption, for each individual company, using the
measures presented below.
3.2 Readability/complexity measures
The FleschKincaid grade formula is the primary readability indicator adopted, being
based on the original Flesch Reading Ease formula (Flesch, 1948) but modified in 1975 to
allow for easier interpretation (Kincaid et al., 1975). However, for the purpose of
completeness, other indicators to measure readability are put forward and included in
the descriptive statistics and bivariate analysis to determine if the various readability
measures give similar results. These include the Flesch formula, the Smog formula and
the Fog formula. Further details on these readability indicators can be found in
Appendix. These indicators were extracted from a computational linguistics
programme (i.e. Readability Calculations by Micro Power & Light) once the raw data
had been imported from the annual reports of the sample companies. We also do

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robustness tests where we use report length and number of tables as proxies for
readability this is discussed in a later section.
For a number of years leading up to the adoption of NZIFRS, New Zealand companies
were required to disclose a note on the impact of IFRS adoption on the company. For the
purposes of our study, we exclude this note as well as disclosures relating to first-time
adoption of NZIFRS from our analysis. This was done, as we specifically want to
compare disclosures pre- and post-adoption of NZIFRS and therefore disclosures
specifically and only related to the transition to NZIFRS are not relevant to our analysis.
3.3 Control/other measures
Our analysis controls or accounts for a variety of other variables that have been shown
by prior literature to be associated with annual report readability or have the potential
to influence this. As discussed below, these variables include size, business volatility,
leverage and industry.
3.3.1 Size. It has been argued that size can capture many aspects of a firms
operational and business environment (Li, 2008). We included size as we expect larger
companies to have longer and more complex annual reports and disclosures, a notion
supported by Bradbury (1992) but opposed by Lis (2008) findings. We define company
size as the natural logarithm of market value (represented in thousands) for the fiscal
year, similar to Al-Tuwaijri et al. (2004). Market value was extracted from the Osiris
database (where available), with any missing data being calculated by applying the
adjusted closing value of a companys shares as at balance date (extracted from Yahoo
Finance) to the number of outstanding shares at that date as disclosed within the Osiris
database. Comparisons were made to ensure that the calculated data via this method
matched the data that Osiris reported, and no discrepancies were noted.
3.3.2 Business volatility. Communications or disclosures to investors by companies
operating in more volatile business environments can be more lengthy and complicated.
Li (2008) found a statistically significant relationship between a volatility indicator and
the Fog grade score of financial disclosures. Similarly, we use company-specific stock
price volatility as an indicator of business volatility, measured as the standard deviation
of the adjusted weekly closing stock price for each relevant year. Historical,
weekly-adjusted, closing stock prices were extracted from Yahoo Finance for all the
companies investigated and imported into Microsoft Excel to calculate the relevant
years standard deviation (volatility indicator).
3.3.3 Leverage. A firms leverage can be associated with its level of disclosure, as
additional disclosures related to financial instruments, debt covenants and risk could be
required. For example, Bradbury (1992) investigated the extent of voluntary segment
disclosure by 29 multi-product firms listed on the New Zealand Stock Exchange and
found significant relationships between company leverage and disclosures. We use the
year-end debt to equity ratio (Total Debt and Liabilities/Shareholders Equity) as an
indicator to determine if leverage is related to the readability of accounting disclosures.
3.3.4 Industry. The premise behind this measure is that companies in specific
industries may well have naturally more complicated annual reports, as was found by Li
(2008). For the purpose of this investigation, the operational industry of each company
was simplified into energy, goods (production), industrial, investment (financial),
primary (resource) or services with a dichotomous variable created for each industry

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classification used to capture the event of operating within that industry (1) or not
operating in that industry (0)[7].
We use a dichotomous or dummy variable to distinguish if companies have adopted
International Financial Reporting Standards (NZIFRS) (1) or not (0).
3.4 Sample
The population under investigation in this paper is NZX50-listed companies. To
maximise the number of companies investigated, the companies need to be listed on the
NZX50 on either 21 August 2006 (a date before IFRS was implemented in New Zealand)
or 15 May 2010 (a date after the implementation). With this company pool, we
investigate what effect moving from NZFRS to NZIFRS has had on the readability of
annual report disclosures. As such, only companies that adopted and report under
NZIFRS, while previously reporting under NZFRS, were investigated. In addition,
companies were required to have at least three reports available prior to NZIFRS
adoption and two after adoption.
In total, 180 annual reports were analysed (three annual reports under NZFRS and
two under NZIFRS for each company), made up of 108 reports pre-IFRS and 72 under
IFRS (NZIFRS). The services sector made up the majority of the reports (41.7 per cent),
with the investment sector and primary sector coming in second equal, making up 16.7
per cent each. Company data including company name, location and operational
industry were extracted from the Thomson Reuters DataStream.
4. Results
4.1 Descriptive statistics
Table I Panel A provides descriptive statistics for the dependent variables, being the
different readability measures. All four readability indicators suggest that a university
graduate level of education is generally required to read and comprehend the annual
report disclosures. The mean Flesch score achieved by the 180 annual reports analysed
was 29, with a range of 35 points (7-42). The FleschKincaid grade level mean was the
lowest grade at 15.14, suggesting at least an undergraduate level of education is
needed to comprehend the disclosures. The mean Smog grade level was 16.51, while the
Fog grade level was the highest at 18.23, suggesting up to a masters level of education
would be required. Table II provides the mean scores of the annual reports over the
five-year study with an indication from the readability literature as to the level of
education required to understand written texts at that level.
When the statistics are split into two groups pre-adoption of NZIFRS and
post-adoption, it becomes apparent that the readability indicators have experienced
some change. We do further tests to determine if the differences experienced between the
pre- and post-means are statistically significant (Section 4.3).
Table I Panel B provides the descriptive statistics for the three control variables,
namely, Size, Leverage and Volatility. All three controls have large range values
indicating the diversity of companies included within our investigation. Leverage and
Volatility indicators had mean values of 1.68 and 0.41, respectively, while the Size
indicator had a mean value of 6.28.
Because statistical models often assume a normal distribution of data, we run some
tests on our data (KolmogorovSmirnov and ShapiroWilk) and find that the data
distribution is not normal, suggesting that care must be taken in the use of tests that

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assume normality. For this reason, our analysis includes tests that do not assume
normality wherever possible, for example Spearmans Rho, Kendalls-tau and the
Wilcoxon test.
4.2 Correlation
Table III presents Spearmans Rho (bottom left diagonal) and Kendalls-tau (top right
diagonal) bivariate correlation matrixes, with significant correlations highlighted in
bold. While not included in the table, of the six industry classification variables
identified, only the industrial and primary sectors had any relationship with the
readability indicators. Industrial classification was found highly significant (0.01,
two-tailed) and positive indicating that industrial companies had more readable
reports under all indicators, while the primary industry classification was found
significant with the FleschKincaid, the Smog grade (at the 0.05 level, two-tailed) and
highly significant with the Flesch score (0.01, two-tailed). These three relationships were
negative in nature, indicating companies in the primary industry had disclosures that
NZIFRS

Mean

Minimum

Maximum

Range

Panel A: readability indicators

Pre adoption
Flesch
108
FleschKincaid
108
Fog
108
Smog
108

29.5648
14.9176
18.0324
16.3815

12.00
12.30
15.60
14.50

42.00
19.80
22.80
19.80

30.00
7.50
7.20
5.30

Post adoption
Flesch
FleschKincaid
Fog
Smog

72
72
72
72

28.1250
15.4778
18.5347
16.6958

7.00
11.40
14.60
13.30

41.00
20.80
23.80
20.50

34.00
9.40
9.20
7.20

Total pool
Flesch
FleschKincaid
Fog
Smog

180
180
180
180

28.99
15.14
18.23
16.51

7.00
11.40
14.60
13.30

42.00
20.80
23.80
20.50

35.00
9.40
9.20
7.20

9.37
8.63
4.63

5.17
8.58
4.62

Panel B: other variables

Size
180
Leverage
180
Table I.
Descriptive statistics Volatility
180

Indicator
Table II.
Summary table:
readability scores
and census data

Flesch
FleschKincaid
Fog
Smog

Mean score
29
15
18
17

6.28
1.53
0.410

4.20
0.052
0.005

Minimum required education level

Bachelor degree and level 7 qualification
Post-graduate and honours degrees
Masters degree
Post-graduate and honours degrees

% Population that
can comprehend
16
5
2
5

0.009
1.000
0.234**
0.151*
0.091
0.071
0.050
0.085

1.000
0.006
0.376**
0.101
0.060
0.069
0.049
0.005
0.253**
0.153**
1.000
0.397**
0.334**
0.312**
0.313**
0.136

Volatility

FleschKincaid
0.047
0.062
0.229**
0.706**
1.000
0.981**
0.974**
0.220**

Flesch
0.067
0.104*
0.274**
1.000
0.854**
0.837**
0.855**
0.115
0.051
0.048
0.213**
0.691**
0.899**
1.000
0.984**
0.204**

Fog

NZIFRS
0.004
0.070
0.112
0.096
0.182**
0.169**
0.159*
1.000

Smog
0.041
0.034
0.211**
0.710**
0.885**
0.922**
1.000
0.191*

Notes: Spearmans Rho is correlation reported in the bottom (left) diagonal and Kendalls-tua correlation in the top (right) diagonal; volatility, Leverage
and IFRS correlations with readability indicators (Flesch, FleschKincaid (FleschKincaid), Fog and Smog) have significance levels that are all one-tailed
test results. All other correlations have significance levels quoted from two-tailed tests; * correlation is significant at the 0.05 level; ** correlation is
significant at the 0.01 level

Size
Leverage
Volatility
Flesch
FleschKincaid
Fog
Smog
NZIFRS

Leverage

Size

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Table III.
Spearmans Rho and
Kendalls-tau
correlations
(n 180)

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were more difficult to read. The literature has suggested that some industries may have
more complicated annual reports (Fleck and Ceams, 2008; Li, 2008; Stanga, 1976) and our
results confirm this. However, why the primary industry in New Zealand had
disclosures that were more difficult to read is not clear from the literature. We suggest
this result could be attributed to the nature of primary industry companies, which are
typically export orientated and will therefore be more likely to use complex financial
instruments that could complicate their reporting. All other industry classifications
failed to achieve any level of significance. The commonly used Pearson correlation
matrix, which assumes a normally distributed population, was also run. This matrix
discovered all the relationships with the readability indicators that the non-parametric
correlations above discovered. However, in addition, it also found the Flesch score
related to NZIFRS at the 0.05 significance level and size related to all readability
indicators to the 0.01 level.
The general sets of correlations that are of interest to this paper are correlations with
readability indicators. In this regard, the Spearmans and Kendalls correlations
revealed the same significant relationships, with only their coefficients varying.
Utilising these correlations, the following significant relationships were identified. It
should be noted that the key relationships of interest in this research are the
relationships between our readability measures and NZIFRS. The other relationships,
while interesting, are secondary to this and ultimately were included so we could control
any influence these may have on our primary hypothesis during our multivariate
analysis:
NZIFRS has significant correlations with almost all the readability indicators
with the exception of the Flesch score. These correlations are at the 0.01 level
except for Smog, which is at the 0.05 level. The direction of the relationship
suggests that the adoption of NZIFRS is related to more complicated and less
readable disclosures.
Business volatility has significant correlations with all four readability indicators
(0.01 level). The four co-efficient directions suggest more volatile businesses have
more complicated and less readable disclosures. This was expected based on the
literature that suggested that firms operating in more volatile business
environments can be more lengthy and complicated, and that business volatility
has a negative relationship with readability (Li, 2008). While it was not the aim of
this research to investigate why these relationships exist, it could be that
companies experiencing volatility typically have complicated financial situations
that are being disclosed to the public, thereby leading to less readable notes.
Further research is required to understand why this relationship exists.
Leverage has a significant correlation with the Flesch score at the 0.05 level. This
suggests that companies with higher leverage have more complicated and less
readable disclosures. This was expected based on Bradbury (1992) work that
found a relationship between leverage and disclosures. It could be attributed to
additional disclosure requirements imposed by lenders on companies that have
higher debt levels. Further research is required to explore this relationship.
On the bivariate level, we fail to find any significant relationship with company size, and
our findings therefore do not confirm those of the study of Bradbury (1992) (that

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company size and leverage are negatively related to readability). Our findings confirm
the findings of Li (2008) that business volatility has a negative relationship with
readability. In addition, our findings also confirm the findings of Li (2008) regarding a
relationship between readability and industry (also proposed by Stanga, 1976).
Our readability indicators are also highly correlated with each other (at the 0.001
level and with coefficients ranging from 84 to 97 per cent), and in the direction that we
expected, in that a reduction in the Flesh score represents more difficulty, while an
increase in the other scores (FleshKincaid, Smog and Fog) represents more difficulty.
The high correlation between our readability indicators is evidence of the internal
validity of our indicators and that they measure the same concept.

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4.3 Paired mean difference

Each company had an average pre- and post-NZIFRS adoption value calculated for each
readability variable under investigation. Both a paired-sample Wilcoxon Signed Ranks
test (pre- and post-adoption) which does not assume normality, and a paired sample
t-test that does assume normality, were conducted on these variables. The results are
summarised in Table IV, including the significance levels and implied direction from
pre-adoption.
These tests provide evidence that there has been a change in the mean readability
scores from pre-NZIFRS adoption to post adoption. Provisionally, this suggests that the
null hypothesis of no relationship between NZIFRS adoption and readability may be
rejected. Our bivariate analysis therefore confirms our hypothesis that the adoption of
IFRS reduced the readability of annual report disclosures.
It is also clear from Table III that many other factors are also significantly correlated
to readability (e.g. volatility and leverage), and this gives added justification for our
decision to control for these factors in a multivariate analysis.
4.4 Multivariate analysis
A Linear Regression model is presented in this section with the readability indicator
(FleshKincaid) as the dependant variable and the remaining variables (NZIFRS
adoption, leverage, volatility, size and industry) as independent variables. The purpose
of this is to exert statistical control and isolate any potential relationship between
NZIFRS and the dependant readability indicators. The following general model is
tested:

Pre Flesch vs Adopt Flesch

Pre FleschKincaid vs Adopt FleschKincaid
Pre Fog vs Adopt Fog
Pre Smog vs Adopt Smog

Wilcoxon test
Significant
Direction

t-test
Significant
Direction

Yes at 0.05
Yes at 0.01
Yes at 0.01
Yes at 0.01

Yes at 0.05
Yes at 0.01
Yes at 0.05
Yes at 0.05

Decrease
Increase
Increase
Increase

Decrease
Increase
Increase
Increase

Notes: Significance tests results shown above are one-tailed; the expected signs for the Flesch Model
differ from those of the remaining three models due to the reversed scoring method, i.e. the Flesch
method scores narrative from 1 (poor readability) to 100 (high readability), the remaining models rate
the grade level required to comprehend the narrative and as such high values represent poorer
readability

Table IV.
Paired mean test
summary results

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Readability 1( NZIFRS ) 2( Leverage ) 3( Volatility ) 4( Size )

5( Industry ) e
where:
The dependant variable is the FleschKincaid grade
indicator;
NZIFRS
The dichotomous variable capturing the event of
reporting under NZIFRS. Represented as 1 if the
annual report is prepared under NZIFRS, otherwise
0;
Leverage, Volatility and Size Control variables as discussed previously; and
Industry
Energy, goods, industrial, investment, primary and
services are the control variables for industry
effects.
Readability

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Table V shows the results from the linear regression. Readability is significantly related
to IFRS adoption at the 1 per cent level, after including the control variables. The model
is significant and the adjusted R2 value is 17.2 per cent. The relationship with NZIFRS
adoption is in the direction hypothesised, that is, IFRS adoption has led to reduced
readability[8].
With regards to the control variables, they are all in the expected direction. Leverage
is not significant, while volatility and size are significant at the 5 per cent level. The
relationship with volatility suggests that businesses operating in more volatile business
environments have more complicated disclosures that are harder to read. The model
also suggests that larger companies have less readable disclosures. The industry
variables suggest that companies in the primary industry have less readable disclosures
(at the 5 per cent level), while companies in the industrial industry classification have
more readable disclosures (at the 1 per cent level). The finding for industries therefore
confirms that of the bivariate analysis, discussed earlier.

Sign
Constant
NZIFRS
Leverage
Volatility
Size
Primary
Industrial
F value
Adj. R2
Table V.
Multivariate results
readability scores

13.523

0.197
0.649
1.416
7.217
0.172

FleschKincaid Model
Coefficient
0.000**
0.548
0.010
0.346
0.011*
0.022*
0.002**

p value
0.004**
0.433
0.032*

Notes: Where direction is expected (see sign column); significance level is one-tailed, else
two-tailed; * correlation is significant at the 0.05 level; ** correlation is significant at the 0.01 level

4.5 Annual report statement length

We were interested in finding out whether the length of the reports increased following
the introduction of IFRS. Li (2008, p. 225) includes length as an indicator in his paper
Annual report readability, current earnings and earnings persistence stating:

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Because the information-processing cost of longer documents is presumed to be higher,

assuming everything else to be equal, longer documents seem to be more deterring and more
difficult to read.

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Indeed, the US Securities and Exchange Commission (SEC) has suggested that companies
avoid lengthy sentences and documents, as these can be unduly complex (SEC, 1998).
We therefore suggest an additional measure/indicator for the complexity of
annual reports, namely, statement length. The premise for this indicator is based on
information overload. We argue that as disclosures expand in length, the quality
of information presented within them deteriorates, as they do not concisely convey
information to readers. Users may therefore find themselves struggling to use
reports effectively or to find useful information within them (Li, 2008). As an
indicator for length, we use the number of pages that contain the general financial
statements and notes (i.e. Income Statement, Balance Sheet, Changes in Equity,
Cash-flow Statement and the Statement of Accounting Policies) represented to the
nearest half page. Similar to the readability formulas above, we exclude disclosures
relating to first time adoption of NZIFRS.
Table VI Panel A provides the descriptive statistics for the length indicator
pre-adoption of NZIFRS, post-adoption and finally in aggregate. Of primary interest is
the large increase in the mean pre-length vs the mean post-length of 17.24 pages or 80 per
cent with the average length of NZIFRS reports being 38.86 pages. Untabulated
bivariate analysis shows that the length indicator is significant with all the independent
variables included, and these relationships are in the same direction as discovered by the
readability analysis. In addition, the analysis shows a relationship with leverage that
the previous readability indicators failed to suggest as significant.
Table VII shows the results of the linear regression for the Length indicator. The
model achieves the strongest fit presented thus far, explaining 61.3 per cent of
the variation in the data set. Similar to the previously presented readability models, the
expected directions for NZIFRS and leverage were discovered, indicating adoption of
NZIFRS and higher leverage results in longer disclosures. However, volatility was
found to be negative and suggests that businesses operating in more volatile business
environments have shorter disclosures. The second interesting result regarded the
NZIFRS

Range

Minimum

Maximum

Mean

SD

Panel A: length of annual reports

Pre-adoption
Length
108
Post-adoption
Length
72
Total pool
Length
180

49.00
65.50
72.50

10.00
17.00
10.00

59.00
82.50
82.50

21.6296
38.8681
28.5250

9.06141
13.71516
13.97896

Panel B: tables in annual report

Pre-adoption
Tables
108
Post-adoption
Tables
72
Total pool
Tables
180

39.00
79.00
92.00

12.00
25.00
12.00

51.00
104.00
104.00

29.6111
54.6667
39.6333

9.98113
14.89021
17.29175

Table VI.
Descriptive statistics

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296

Table VII.
Multivariate results
for length and tables

Sign
Constant
NZIFRS
Leverage
Volatility
Size
Industrial
Primary
Goods
Energy
F-value
Adj. R2

Length model
Coefficient
8.001
16.998
1.462
1.783
4.414
10.282
7.578
7.127
6.392
33.789
0.594

p-value
0.028*
0.000**
0.001**
0.080
0.000**
0.001**
0.000**
0.001**
0.011*

Sign

Table count model

Coefficient
p-value
5.055
24.506
2.233
1.753
3.219
9.425
N/A
9.985
N/A
58.168
0.657

0.190
0.000**
0.000**
0.209
0.000**
0.006**
N/A
0.000**
N/A

Notes: Where direction is expected, significance level is one-tailed, else two-tailed; industry variables
not represented above (i.e. investment and services) failed to meet SPSS tolerance requirements for
inclusion in our model construction. N/A is used in the table count model where the relevant industry
also failed to meet tolerance levels, yet it was included in the length model; * correlation is significant at
the 0.05 level; ** correlation is significant at the 0.01 level

leverage indicator, in contrast to the previous models, was found to be highly significant
at the 0.001 level. Adoption of NZIFRS was significant at the 0.001 level, a result
consistent with the previous models.
Interpreting the results, this model suggests adoption of NZIFRS has resulted in an
almost 17-page increase to disclosure length and therefore added to the complexity of
the disclosures. Leverage is significant at the 0.001 level, indicating that companies
which utilise more debt have longer disclosures. Company size was significant at the
0.001 level, a result similar to the previous readability models, indicating that larger
companies have longer disclosures.
In general, the findings for annual report length support the findings previously
discussed regarding the readability formulas, as previous research has suggested that
longer reports impact the readability of the information (Li, 2008; SEC, 1998) due to
information overload. Arguably, the most interesting finding is regarding the severe
implication that NZIFRS adoption has had on the length of disclosures, with an average
80 per cent increase or 17 pages to the annual report length.
4.6 Number of tables
The adoption of IFRS has given rise to more tables being required. It is unclear how tables
influence the readability of a piece of writing, i.e. do they improve the readability or make it
more difficult to read? We have been unable to find studies that investigate the comparative
readability of tables and text, and, as such, we cannot generalise on the overall readability
implication from having more or fewer tables in disclosures, based on the literature[9].
On a cautionary level, we suggest having more tables could result in deteriorated
readability. We argue this as tables are technical in nature and provide very specialist
information that readers must individually interpret and form conclusions on, often with
little or no guidance or inferences being available from the surrounding text. Because the
readability formulas used in this paper required the exclusion of tables (as these did not

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represent the typical structure or content of prose), focusing specifically on tables may
provide a way to overcome this limitation. To capture the effects of NZIFRS adoption on
tables, a simple table count was conducted on the disclosures in the 180 annual reports.
Table VI Panel B provides the descriptive statistics for the table count variable. The
mean number of tables increased by 85 per cent after adoption of NZIFRS, up from 29.6
pre-adoption to 54.7 post-adoption. Likewise, both the minimum and maximum table
counts experienced just over a 100 per cent increase after adoption. Also interesting is
the 100 per cent increase in the range experienced at the onset of NZIFRS adoption and
the increase in standard deviation, suggesting the adoption of NZIFRS has had varying
levels of effect for the different companies use of tables[10].
Table VII provides the linear regression for the table count. This model achieves the
strongest fit of all the models presented in this paper, accounting for 66.9 per cent of the
variation in the data set. Adoption of NZIFRS was found to be a highly significant indicator
for the table count model (at the 0.000 level). This indicates that the adoption of NZIFRS has
resulted in an average of 24 more tables. Indeed, based on the standardised beta values, this
is the largest contributor to the models output. In addition, four further control variables
were found to be significant. Leverage was significant at the 0.000 level, a result similar to the
Length model, suggesting companies with higher leverage have more tables. Company size
was significant at the 0.000 level, indicating that larger companies have more tables. Finally,
two industry controls were found to be significant. Companies classified within the goods
industry have around 10 more tables than the industry base and companies within the
industrial classification had around 9.5 fewer tables than the industry base level.
The adoption of IFRS has therefore led to more tables in the annual report. This is in
itself an interesting finding. It is not clear how this affects the readability of the reports.
While we argue that tables are technical in nature and provide very specialist
information which could make them less readable to the general public, we also accept
that tables may make a document more readable for a technical audience; for example,
qualified accountants and analysts may find tables easier to read and understand than
pages of text. The literature is silent on this issue.
5. Discussion and conclusion
We hypothesised that the introduction of International Financial Reporting Standards
in New Zealand could lead to increased difficulty in reading the resulting financial
statements. Our results show that the readability of financial statements decreases after
IFRS adoption in New Zealand. The results hold after controlling for other variables that
previous research had identified as being significantly related to financial disclosures
readability (size, leverage, volatility and industry) and therefore support our hypothesis.
We have found sufficient evidence to conclude that the adoption of IFRS has led to more
complicated narrative annual report disclosures. These relationships reveal a troubling
situation; adoption of IFRS has deteriorated the readability of annual report disclosures
and resulted in considerably longer and more complicated reports with more tables.
While the direct cause of this relationship is not investigated in this paper, it is evident
that work is required to remedy this result of IFRS adoption.
Weeks and Wallaces (2002) paper was the first academic paper to make use of
Readability Calculations by Micro Power & Light. Our paper represents the first time
it has been utilised in an accounting context. We have found its use highly reliable and
robust. It could easily be used in other studies that in the past had to manually compute

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the outputs or relied on outputs offered by programs such as Microsoft Word that are
not expressly intended for readability analysis. We have identified implications that
the adoption of NZIFRS has had on annual reports that other papers (which have
predominantly concentrated on the financial implications) have not touched on. The
adoption of NZIFRS has resulted in deteriorated readability of disclosures and marked
increases in length of 80 per cent and an 85 per cent increase in the use of tables. Further,
we add to existing literature by providing evidence of some elements that influence the
readability of annual report disclosures, supporting the results of some prior studies
while countering the findings of others.
We are the first to provide evidence that NZIFRS adoption has resulted in not only
longer disclosures but also more complicated disclosures. We suggest that further work
is needed on the development of IFRS, focusing on the resulting financial reports. It is
hoped that academic backing to claims of IFRS negative implications for financial
statements and their ultimate users will encourage action on the part of standard setters
and report preparers to address the negative impacts of IFRS adoption.
5.1 Limitations
As discussed before, it is our opinion that the use of readability formulas in accounting is
valid and of benefit. Nevertheless, we must acknowledge that there is debate over the general
applicability of readability formulas in the accounting context (Stevens et al., 1992; Sydserff
and Weetman, 1999). While we accept that technical material could produce unduly inflated
difficulty levels, we rely on Flory et al. (1992) who suggest that this is only an issue if the
researcher attempts to determine an absolute reading level, i.e. when one seeks to provide a
definitive grade level required for comprehending a piece of writing. When used solely for
comparative purposes between equally technical documents, such as yearly comparisons of
annual reports, the issues raised as criticism above pose no material limitations. While there
are many other techniques to determine readability (for example, qualitative tests such as
checklists, levelling systems or content analysis), our results show, using a range of
techniques, that the general readability of the reports has declined and that they have
become longer and contain more tables. It is therefore unlikely that a more nuanced analysis
will show different results.
A shortfall of the readability indicators is their inability to capture the complexity of tables in
the text due to the removal of tables and figures in their analysis. While the report length would
have reflected this, a more appropriate measure was adopted, namely, a table count. However,
other indicators may be able to capture the implication that the increased use of tables following
the adoption of IFRS had on the readability of the underlying document.
5.2 Possible future research
In future, more robust research could be achieved by adding indicators such as table row
counts (for better capturing of the effect of tables on readability), utilisation of the Cloze
procedure as a readability indicator (Stevens et al., 1992) or, alternatively, by utilising a
survey-based investigation or doing content analysis on the reports to determine
changes in readability. Similarly, more predictors could be included in an attempt to
understand what affects annual report disclosures. Suggested variables could be
auditors, company age, turnover, geographic sectors of operations and senior
management indicators. These could provide valuable insights into understanding
interactions with disclosures.

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This paper aimed to identify if there is any relationship between IFRS adoption and the
readability of the resulting annual reports. While we achieved our aim, it was not possible to
identify why this has resulted or how to address the issue. Future research could look into
this, with the aim of explaining why readability decreased with IFRS adoption and to explore
the other relationships we identified. Future research is required to ultimately provide advice
on how to improve the readability of annual reports in respect to both improvements in
accounting standards and improvements in general reporting practices.
Finally, an international study of IFRS adoption in various countries on a much
larger scale could provide more robust and informative findings that may better inform
standard setters of the standards current weaknesses.
Notes
1. New Zealand decided to adopt IFRS almost verbatim, following the decisions of the European
Union and, consequently, Australia, to adopt IFRS.
2. For a summary of the use of IFRS by domestic, listed and unlisted companies around the
world for external financial reporting, see www.iasplus.com/country/useias.htm
3. The ASRB is the New Zealand body responsible for reviewing and approving proposed
financial reporting standards. The FRSB is part of the New Zealand Institute of Chartered
Accountants (NZICA), and although it does not have a monopoly over standard setting, is the
only body to ever issue a standard in NZ (Bebbington and Song, 2003, p. 28). The New
Zealand standards are called either New Zealand International Financial Reporting
Standards (NZIFRS) or New Zealand International Accounting Standards (NZIAS).
4. Sector neutrality means that financial reporting standards are applicable to all entities,
irrespective of what sector they operate in (Lee and Teixeira, 2004). IFRS are tailored for
profit-oriented entities, but New Zealand intends to apply them to all entities including
not-for-profit and third sector (Bebbington and Song, 2003).
5. Rates text on a 100-point scale using the average number of syllables per word and words per
sentence. Mathematically represented as FRE 206.835 (1.015 ASL) (84.6 ASW)
where FRE represents score, ASL the average sentence length and ASW the average syllables
per word (Flesch, 1948).
6. Another aspect of annual report readability research focuses on good communication versus
obfuscation. This forms part of the impression management literature, which considers
whether management is neutral in its presentation in accounting narratives (Sydserff and
Weetman, 1999). This line of research is not relevant to our paper, in that we want to
determine if the disclosures required by IFRS are more difficult to read and therefore have
nothing to do with impression management.
7. These industries were prevalent among the NZX50 companies at the time of our research.
Company classification is based on disclosure on the New Zealand Stock Exchange.
8. We also ran the model with the other readability indicators (Flesh, Fog and Smog) and found
significance in the hypothesised direction with IFRS adoption. That is, all the readability
indicators show that IFRS adoption has led to (significant) reduced readability.
9. There is, however, research that has looked at how graphs, images and tables have been used
in annual reports under the scope of impression management (i.e. this area of research has
looked into how companies selectivity use graphs, images and tables to inflate the appearance
of performance or obfuscate poor performance). This research is not directly applicable to our

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research, as we are interested in how the number of tables required changed under IFRS and
whether this could impact the readability of the financial reports.
10. A correlation (untabulated) was also run between all four readability formulas, the length
indicator and the number of tables. This correlation discovered all to be significantly related
at the 0.005 level (two-tailed).

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Further reading
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No. 6, pp. 436-442.

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Appendix. Readability measures

Flesch reading ease
The Flesch Reading Ease readability formula is used in business, industry and government, as
well as education, to score materials from the upper elementary level on through college levels.
The formula takes into consideration:
the total number of words;
the number of syllables; and
the total number of sentences. Unlike most formulas, which report their results as
grade-level scores, the Flesch Reading Ease formula reports its results on a difficulty scale
ranging from 0 to 100.
The higher the number readability scale score, the easier the material. For example, a readability
scale score between 90 and 100 indicates the material is appropriate at the fifth grade level,
whereas a score between 0 and 30 indicates material requiring the reader be a college graduate
(Table AI).
Flesh Kincaid
The Flesch Grade Level readability formula is also sometimes referred to as the FleschKincaid
formula. It takes into consideration:
the total number of words;
the number of syllables; and
the total number of sentences.
The Flesch grade level formula is used in business, industry and government, as well as
education, to score materials from the upper elementary level through the secondary grades
and beyond. For example, Pennsylvania was the first state in the USA to require that
automobile insurance policies be written at no higher than a ninth grade level (14-15 years of
age) of reading difficulty, as measured by the F-K formula. This is now a common
requirement in many other states and for other legal documents such as insurance policies.
The FleschKincaid formula gives the number of years of education that a reader must have to
understand the material; with 12 indicating school level, 16 that a degree is required and 18 that a
masters degree is required.
FOG formula
The FOG readability formula is widely used in the health-care industry and throughout the entire
business community. The FOG formula takes into consideration:

Table AI.
Flesch reading ease
difficulty scale

Score

Notes

90.0-100.0
60.0-70.0
0.0-030.0

Easily understood by an average 11-year-old student

Easily understood by 13- to 15-year-old students
Best understood by university graduates

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the total number of words;

the number of words of three or more syllables; and
the total number of sentences.
As applied in industry and business, many reading experts feel that no technical material should
score higher than grade level 14, no business material higher than grade level 12 and no clerical
material higher than grade level 8.
The FOG formula gives the number of years of education that a reader must have to understand
the material, with 12 indicating school level, 16 that a degree is required and 18 that a masters
degree is required.
SMOG formula
The SMOG formula takes into consideration:
the total number of sentences; and
the number of words of three or more syllables.
Because SMOG readability formula aims for 100 per cent comprehension, its grade-level scores
are usually higher than any of the other formulas, most of which target between 50 and 75 per cent
comprehension.
The SMOG formula gives the number of years of education that a reader must have to
understand the material, with 12 indicating school level, 16 that a degree is required and 18 that a
masters degree is required.
Adapted from www.micropowerandlight.com/
Corresponding author
Chris van Staden can be contacted at: chris.vanstaden@aut.ac.nz

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