Impairment reversals: unbiased reporting or earnings management

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 information about a company. Design/methodology/approach The authors use a sample of 182 Malaysian firms that reversed impairment charges and a matched sample of firms which chose not to reverse their impairments. Further analysis examines if reversing an impairment charge is associated with motivations for and evidence of earnings management. Findings The authors find no evidence that the reversal of an impairment charge marks a company out as managing contemporaneous earnings. However, they document evidence that firms with high levels of abnormal accruals and weak corporate governance avoid earnings decline 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 opportunistic hypotheses of impairment reversal reporting using Financial Reporting Standard 136. Practical implications The results also demonstrate how companies that use impairment reversals opportunistically can 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.

The effects of global financial crisis on the relationship between CEO compensation and earnings management

“…Recently, Sun and Al Farooque (2017) show that the extent of firms' earnings management is not reduced after the reformation of corporate governance in Australia and New Zealand. Cao et al (2018) document that if a firm has high abnormal accruals and weak corporate governance it prevents earnings declines through reversing impairments which was recognised in the previous years.…”

The effect of earnings management on external loan price: evidence from China

“…Previous studies have documented numerous reasons for earnings manipulation, such as avoiding earnings decreases or losses (Burgstahler and Dichev, 1997; Mostafa, 2017), hitting earnings targets (Graham et al , 2005; Cao et al , 2018), satisfying dividend demand (Bernard and Skinner, 1996), achieving promotion (Noronha et al , 2008) or maximizing earnings-based bonuses (Guidry et al , 1999). In credit relationships, rigid requirements on debt covenants motivate borrowers to whitewash their earnings (Sweeney, 1994; Aljinovic Barac et al , 2017; Chung et al , 2021), especially for those at the edge of default (DeFond and Jiambalvo, 1994).…”

Do sin firms engage in real activities manipulation to meet earnings benchmarks?

“…Earnings management can be classified into two categories, namely, AEM and RAM. AEM involves accounting choices within generally accepted accounting principles (GAAP) that try to obscure true economic performance (Dechow and Skinner, 2000; Sun and Al Farooque, 2018; Cao et al , 2018). For example, Cao et al (2018) report that Malaysian firms avoid earnings declines by reversing previously recognized impairments.…”

“…AEM involves accounting choices within generally accepted accounting principles (GAAP) that try to obscure true economic performance (Dechow and Skinner, 2000; Sun and Al Farooque, 2018; Cao et al , 2018). For example, Cao et al (2018) report that Malaysian firms avoid earnings declines by reversing previously recognized impairments. Hao et al (2015) find that managers are conservative in managing earnings when they first start to take top managerial positions and then become aggressive in the next few years.…”