Impairment reversals: unbiased reporting or earnings management

Date08 May 2018
Published date08 May 2018
AuthorTongyu Cao,Hasnah Shaari,Ray Donnelly
Subject MatterAccounting & Finance,Accounting/accountancy,Accounting methods/systems
Impairment reversals: unbiased
reporting or earnings management
Tongyu Cao
Accounting and Finance Department, University College Cork, Cork, Ireland
Hasnah Shaari
Universiti Utara Malaysia, Sintok, Malaysia, and
Ray Donnelly
Accounting and Finance Department, University College Cork, Cork, Ireland
Purpose This paper aims to provide evidence that will inform the convergence debate regarding
accounting standards. The authors assess the ability of impairment reversals allowed under International
Accounting Standard 36 but disallowed by the Financial Accounting Standards Board to provide useful
informationabout a company.
Design/methodology/approach The authors use a sample of 182 Malaysian rms that reversed
impairment charges and a matched sample of rms whichchose not to reverse their impairments. Further
analysis examines if reversing an impairment charge is associated with motivations for and evidence of
Findings The authors nd no evidencethat the reversal of an impairment charge marks a company outas
managing contemporaneous earnings. However, they document evidence that rms with high levels of
abnormalaccruals and weak corporate governance avoid earningsdecline by reversing previously recognized
impairments. In addition, companies that have engaged in big baths as evidenced by high accumulated
impairment balances and prior changes in top management, use impairment reversals to avoid earnings
Research limitations/implications The results of this study support both the informative and
opportunistichypotheses of impairment reversal reportingusing Financial Reporting Standard136.
Practical implications The results also demonstrate how companies that use impairment reversals
opportunisticallycan be identied.
Originality/value The results support IASBs approach to the reversal of impairments. They also
provide novel evidence as to how companies exploit a cookie-jar reserve created by a prior big bath
Keywords Earnings management, Fair value, Abnormal accruals, Big bath,
Reversal of impairments
Paper type Research paper
1. Introduction
The reversal of an impairment of a non-current asset under International Accounting
Standard (IAS) 36 is an aspect of fair value accounting that has the effect of increasing
current earnings. This studybegins by testing if the Malaysian version of IAS 36, Financial
The authors would like to acknowledge the helpful suggestions of Donal Byard and Len Skerratt.
Any remaining errors are their own. The nancial support of the Graduate School, College of
Business and Law, UCC and Universiti Utara Malaysia is gratefully acknowledged.
Received25 August 2016
Revised20 December 2016
19April 2017
Accepted7 June 2017
InternationalJournal of
Accounting& Information
Vol.26 No. 2, 2018
pp. 245-271
© Emerald Publishing Limited
DOI 10.1108/IJAIM-08-2016-0084
The current issue and full text archive of this journal is available on Emerald Insight at:
Reporting Standard (FRS) 136, is generally applied in an unbiased fashion or if it is used to
opportunistically increase earnings. While FRS 136, a standard based on fair value
accounting, is an improvement in terms of the relevance and timeliness of accounting
information relative to the historical cost approach, it also provides managers with
opportunities to manage earnings.Such earnings management may cause the reversals not
to be a faithful representationof the recovery of the asset values.
It should be noted that the reversal of an impairment charge under IAS 36 is one of the
major differences between the two major accounting standard setting bodies in the world:
the IASB and the Financial Accounting Standards Board (FASB). Thus, there is no
universal agreement on the best way to treat assets which have been impaired and are
reckoned to have recovered some or all of their value. FASB prohibit the reversal of an
impairment charge made against non-current assets on the grounds that an impaired asset
is on a new cost basis. Duh et al. (2009) is the only paper that studies the reversal of
impairments under IAS 36. They reportevidence that companies in Taiwan that have made
larger impairments,use the reversal of such impairments to boost current earnings when the
earnings are below the benchmark of the prior yearsearnings, and conclude that the FASB
approach is justied. The current paper takes a closer look at the reversal of impairments
with a view to providing additional evidence surrounding this question. In addition, the
excellent disclosure practices by the vast majority of Malaysian companies with respect to
accumulated impairment charges allows us to examine the relation between impairment
reversals and prior big baths far more closely.Noting that a prior big bath is an indication of
historical earningsmanagement, we further extend Duh et al.s(2009)analysisby examining
the relation between current earnings management, proxied by abnormal working capital
accruals (AWCA) and impairment reversals. Firms with high positive values for AWCA,
particularly those withweak corporate governance, can be classied as upward managers of
current earnings. The relation between an impairment reversal and its real earnings
management alternativeof an opportunistic asset sale is also discussed.
Our rst research question pertains to theoverall application of FRS 136 and whether it
is used in an unbiased or in an opportunistic fashion. We baseour approach on that of Duh
et al. (2009). These authors examine if a sample of 55 rms that reverse impairments differ
from a sample matched on industry and size in Taiwan. We extend Duh et al.s (2009)
analysis by paying particular attention to rms that have taken a prior big bath and those
that display a tendency to manage current earnings upward using alternative methods.
While Duh et al. (2009) are restricted to considering the reversal of impairments made in
within a period of approximately one to two years, our Malaysiandata allow us consider the
reversal an impairment loss regardlessof when that impairment was made.
The second part of our study endeavoursto distinguish between reversals that are made
to faithfully represent the true valueof assets from those that are done opportunistically.We
are again inuenced by the study of Duh et al. (2009) here and base our analysis on the
relation between the reversal and efforts to avoid an earnings decline. Of particular note in
this part of our study is the exploitation of an interestingaspect of the Malaysian reporting
regime to undertake a novel test of the big bath hypothesis. The extant literatureon the big
bath concentrates more or less exclusively on the time of the big bath itself or a comparison
with times where a big bath is not used (Jordan and Clark, 2004). Noting that a primary
objective of a big bath is to shift income to a future period (Sterling 1974;Levitt, 1998;
Fiechter and Meyer, 2010), we concentrate on how rms use the reversal of impairment
charges to exploit a prior big bath. The unique aspect of Malaysian nancialreporting that
is particularly useful in this regardis the disclosure of the accumulated impairment charges
in Malaysian balance sheets[1]. Thus, we extend the analysis of Duh et al. (2009) by

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT