Impairment reversals: unbiased reporting or earnings management

• Date: 08 May 2018
• DOI: https://doi.org/10.1108/IJAIM-08-2016-0084
• Published date: 08 May 2018
• Pages: 245-271
• Author: Tongyu Cao,Hasnah Shaari,Ray Donnelly
• Subject Matter: Accounting & 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

Abstract

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 firms that reversed

impairment charges and a matched sample of firms whichchose not to reverse their impairments. Further

analysis examines if reversing an impairment charge is associated with motivations for and evidence of

earningsmanagement.

Findings –The authors find no evidencethat the reversal of an impairment charge marks a company outas

managing contemporaneous earnings. However, they document evidence that firms 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

declines.

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 identified.

Originality/value –The results support IASB’s 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

opportunistically.

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 financial support of the Graduate School, College of

Business and Law, UCC and Universiti Utara Malaysia is gratefully acknowledged.

Impairment

reversals

245

Received25 August 2016

Revised20 December 2016

19April 2017

Accepted7 June 2017

InternationalJournal of

Accounting& Information

Management

Vol.26 No. 2, 2018

pp. 245-271

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-08-2016-0084

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

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 year’searnings, and conclude that the FASB

approach is justified. 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 classified 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 first 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 firms 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 firms 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 influenced 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 firms use the reversal of impairment

charges to exploit a prior big bath. The unique aspect of Malaysian financialreporting 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

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