Accounting choices under ifrs and their effect on over-investment in capital expenditures

3.3.2 Sub-samples based on Accounting Choices 
Because fair-value accounting (i.e., revaluation) for 
PPE
was much more 
commonly used under UK GAAP than under most other EU countries’ domestic GAAP, 
I further examine a subset of UK firms within my total sample described above. As 
previously explained, I predict that impairment losses will have less disciplining effect on 
managers of firms with a positive revaluation reserve (i.e., upward revaluations) under 
the fair-value option. Therefore, to identify UK firms that used fair-value accounting 
under 
IFRS
or UK GAAP, I check whether a positive revaluation reserve exists in 
shareholders’ equity. WorldScope does not separate the revaluation reserve of 
PPE
from 
other reserves such as unrecognized gains on available-for-sale securities. Hence, I check 
the firms’ annual reports to make sure that the positive revaluation reserve is for 
PPE
.
26
I 
begin with all UK firms in my total sample and I further require that a firm has an annual 
report under UK GAAP before 
IFRS
mandatory adoption.
27
Panel A in Table C3 presents the accounting choices for 
PPE
under UK GAAP 
and 
IFRS
while Panel B presents how UK firms switched between accounting choices 
upon the mandatory adoption of 
IFRS
in 2005. Under UK GAAP, 68 firms used historical 
cost accounting with impairment testing while 33 firms used fair-value accounting for 
PPE
. Out of these 33 firms, 30 firms switched from fair-value accounting under UK 
GAAP to historical cost accounting with impairment testing under 
IFRS
. Only one firm 
switched from historical cost accounting with impairment testing under UK GAAP to 
26
I also check the annual reports of UK firms that had no or zero revaluation reserve in equity to make sure 
that these firms were using historical cost accounting for 
PPE
. Few UK firms closed the balance in their 
revaluation reserve for 
PPE
during 2004. I consider these firms as firms that used fair-value accounting in 
the pre-
IFRS
period.
27
IFRS
1 (First-time Adoption) permits firms to revalue their 
PPE
at fair value once on transition and then 
account for these revalued assets at cost in the post-
IFRS
period. Four UK firms in my total sample that had 
used historical cost accounting with impairment testing before 2004 elected to revalue on transition in 2004 
according to 
IFRS
1. I consider these firms as firms that used historical cost accounting with impairment 
testing in the pre- and post-
IFRS
periods.

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24 
fair-value accounting under 
IFRS
. As a result, a total of 97 firms representing 96% of UK 
firms in my sample used historical cost accounting with impairment testing under 
IFRS
whereas only four firms representing 4% of UK firms in my sample used fair-value 
accounting under 
IFRS
.
In sum, Table C3 shows that when there was a choice between fair-value 
accounting and historical cost accounting with impairment testing following the 
mandatory adoption of 
IFRS
, UK firms typically chose historical cost accounting with 
impairment testing. This finding is consistent with those of the Institute of Chartered 
Accountants in England and Wales’ (ICAEW) 2007 report and Christensen and Nikolaev 
(2010) that find most EU firms elected to use historical cost accounting with impairment 
testing for 
PPE
after 
IFRS
adoption.
To test my second hypothesis (H2), I divide my total sample into two sub-
samples. The first sub-sample of firms, which I label as 
FV_HS
, consists of the 30 UK 
firms (Table C3 – Panel B) that used fair-value accounting (
FV
) under UK GAAP and 
then switched to historical cost accounting with strict impairment rules (
HS
) under 
IFRS
. 
The second sub-sample of firms, which I label as 
HL_HS
, consists of the remaining 291 
EU firms in my total sample that predominantly used historical cost accounting with 
loose impairment rules (
HL
) under domestic GAAP and historical cost accounting with 
strict impairment rules (
HS
) under 
IFRS
.
28
I predict that over-investment in 
PPE
will be 
lower for the two sub-samples following 
IFRS
adoption (hypothesis 1), but the reduction 
in over-investment will be greater among 
FV_HS
firms relative to 
HL_HS
firms 
(hypothesis 2). 
 
28
As a robustness check, I also remove from this sub-sample the 4 UK firms that used fair-value 
accounting under both UK GAAP and 
IFRS
or switched from historical cost accounting with loose 
impairment rules under UK GAAP to fair-value accounting under 
IFRS
(Table C3 – Panel B). The results 
(untabulated) are similar. 

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25 
CHAPTER IV 
RESULTS