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

PPE
under UK GAAP and then switched to historical cost 
accounting with impairment testing under 
IFRS
had to close, on transition to 
IFRS
, the balance in their 
revaluation reserve. 

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7 
To address the effects of the economic downturn and other institutional factors 
(e.g., enforcement mechanism) on my results, I examine only UK firms that were subject 
to the same economic downturn and institutional factors. I find that UK firms that 
switched from fair-value accounting under UK GAAP to historical cost accounting with 
impairment testing under 
IFRS
exhibit greater reductions in over-investment after 
IFRS
adoption relative to 
other UK firms
. This finding mitigates the concern that the reduction 
in over-investment after 
IFRS
adoption is an effect attributed to the economic downturn 
or to other institutional factors. 
Prior literature (e.g., LaFond and Roychowdhury 2008; LaFond and Watts 2008; 
Ahmed and Duellman 2010) shows that timely loss recognition is a governance 
mechanism that mitigates agency conflicts between managers and outside shareholders. 
As a supplemental test, I examine the effect on over-investment based on the level of 
agency conflicts. If EU firms are indeed using historical cost accounting with strict 
impairment rules (i.e., more timely loss recognition) for 
PPE
following 
IFRS
adoption, 
then I predict that as the level of agency conflicts increases, the greater will be the effect 
of timely loss recognition on reducing over-investment. My results are consistent with 
this prediction. After 
IFRS
mandatory adoption, outside shareholders appear to be 
demanding timely loss recognition as a means of addressing agency conflicts with 
managers.
This study contributes to the accounting literature in several ways. First, my paper 
contributes to the international accounting literature by examining the effect firms’ 
accounting choices following mandatory 
IFRS
adoption have on firms’ investment 
efficiency. My findings suggest that the increase in investment efficiency for 
PPE
(i.e., 
lower over-investment) following mandatory 
IFRS
adoption is not uniform among firms. 
Rather, the investment efficiency benefits are dependent on the accounting choices that 
firms followed prior to 
IFRS
and the option they chose after the mandatory adoption of 
IFRS
. Understanding the effect of 
IFRS
accounting choices on investment efficiency is of 

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8 
potential interest to standard setters and regulators in countries that are considering 
IFRS
adoption as well as in countries that have already adopted 
IFRS
.
Second, my paper contributes to the literature on the effects of conservative 
financial reporting (i.e., timely loss recognition). Prior studies (e.g., Francis and Martin 
2010; Srivastava et al. 2010; Ahmed and Duellman 2010) show that conservative 
financial reporting reduces over-investment. These studies examine firms under one set 
of domestic standards, U.S. GAAP, where all firms are required to use historical cost 
accounting for non-financial assets and are subject to the same impairment rules. 
However, in my study, I exploit a setting where firms have changed their accounting 
treatments for 
PPE
from fair-value accounting (or historical cost accounting with loose 
impairment rules) to historical cost accounting with strict impairment rules. Therefore, I 
investigate in a more direct way the effect of conservative financial reporting on over-
investment in 
PPE
. Further, prior studies (e.g., Dietrich et al. 2007; Givoly et al. 2007; 
Gow et al. 2010; Tian et al. 2009) show that it is difficult to reliably measure ‘firm-level’ 
conservatism and that commonly-used conservatism measures, such as the one proposed 
by Basu (1997), suffer from measurement errors. In my study, I do not rely on a ‘firm-
level’ measure of conservative reporting. Rather, I exploit a natural sample partitioning 
based on whether firms used fair-value accounting or historical cost accounting with 
either strict or loose impairment rules for 
PPE
to identify which firms are less 
conservative in measuring 
PPE
than others.
Third, this study provides evidence relevant to the heated debate among 
academics and standard setters regarding whether fair-value accounting for non-financial 
assets is beneficial to stakeholders (e.g., Ball 2006; Barth 2006; Schipper 2005; Watts 
2006).
9
My findings suggest that the reduction in over-investment in 
PPE
after 
IFRS
9
Barth (2006, p. 98) states that in almost every standard-setting project of the U.S. Financial Accounting 
Standards Board (FASB) and the International Accounting Standards Board (IASB), the boards consider 
fair value as a possible measurement attribute. This includes the conceptual framework.

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9 
mandatory adoption is associated with firms’ election to use historical cost accounting 
with strict impairment rules. Hence, my findings imply that any future 
IFRS
standards 
that mandate fair-value accounting for non-financial assets could produce less firm-
specific investment efficiency benefits than the current 
IFRS
standards that allow both 
fair-value accounting and historical cost accounting with strict impairment rules.
The remainder of this paper is organized as follows. Chapter II reviews related 
literature and develops my hypotheses. Chapter III describes my measures, research 
design, and sample. Chapter IV presents my results while chapter V presents my 
supplemental test. Chapter VI concludes.