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

2.1.2 Accounting Choices for PPE before and after IFRS 
Prior to mandatory 
IFRS
adoption in 2005, firms in each of the nine EU countries 
in my sample used domestic GAAP.
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Except for Norwegian GAAP, EU countries’ 
domestic GAAP allowed fair-value accounting (revaluation) for 
PPE
. However, fair-
value accounting for 
PPE
in most EU countries was much less common than in the UK. 
For example, fair-value accounting for 
PPE
was very rare in practice under French 
GAAP because upward revaluations were taxed (Deloitte & Touche 2001). In addition, 
very few Swedish firms used fair-value accounting for 
PPE
because Swedish GAAP 
allowed upward revaluations under strict conditions -- when upward revaluations were 
considered permanent, significant, and reliable (KPMG 2005; 
www.iasplus.com/country/sweden.htm). Also, Spanish GAAP allowed upward 
revaluations only after government approval (www.bde.es). In sum, except for UK firms, 
11
See Table C2 (Panel A) for the list of the nine EU countries. 

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EU firms in my sample predominantly used historical cost accounting with impairment 
testing for 
PPE
under domestic GAAP.
12
IFRS
, which became mandatory in EU countries starting in 2005, allows two 
alternatives for measuring 
PPE
. Specifically, IAS 16 (
Property, Plant and Equipment
) 
allows firms to use: (1) historical cost or (2) fair value (revaluation). Furthermore, IAS 36 
(
Impairment of Assets
) requires firms to test whether 
PPE
assets are impaired at each 
reporting date.
13
When using fair value to measure 
PPE
, any impairment loss on a 
revalued asset is treated as a revaluation decrease and will be first reported as an 
adjustment to a revaluation reserve in shareholders’ equity and the excess, if any, will be 
reported in earnings. On the other hand, when using historical cost accounting with 
impairment testing, firms do not revalue their 
PPE
assets upward but only recognize 
impairment losses (i.e., write-downs) directly in earnings.
Table C1 presents a comparison of impairment rules for 
PPE
between 
IFRS
and 
EU countries’ domestic GAAP. IAS 36 establishes detailed procedures for determining 
when impairment occurs and for measuring the amount of impairment. On the other 
hand, most EU countries’ domestic GAAP did not have detailed procedures for 
impairment testing during the pre-
IFRS
period (2000-2004). For example, under French 
GAAP, there were no specific criteria for determining when impairment of 
PPE
occurred 
and the new standard (CRC regulation 2002-10) on impairment of assets, effective on or 
after January 1, 2005, included less guidance than IAS 36 (see 
www.iasplus.com/country/france.htm for more details). Another example is Italian 
GAAP. According to a 2005 comparison of Italian GAAP and 
IFRS
published by the 
European Committee of Central Balance Sheet Data Offices (CBSO), Italian GAAP did 
12
UK, French, Swedish, and Spanish firms represent 86.6% of my total sample (see Table C2 - Panel A). 
13
The International Accounting Standards Board (IASB) issued a revised IAS 16 in December 2003 and a 
revised IAS 36 in March 2004 (IFRS.org). 

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not have standards with explicit criteria for impairment testing. In addition, Dutch GAAP 
had no specific guidance on the recognition of impairment losses on revalued assets 
(KPMG 2006) and Spanish GAAP did not include the cash-generating unit (GCU) 
concept for measuring impairment losses (Callao et al. 2007).
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Overall, most EU 
countries’ domestic GAAP did not have detailed procedures and guidance for 
PPE
impairment testing during the pre-
IFRS
period (2000-2004). Consequently, it is expected 
that managers have more discretion in measuring and reporting impairment losses for 
PPE
under domestic GAAP than under 
IFRS
.
Relative to most EU countries’ domestic GAAP, IAS 36 is considered more 
informative and more transparent because of its disclosure requirement in the notes to the 
financial statements. In a 2009 survey, Ernst & Young find that impairment disclosures in 
financial statements are important to analysts, investors, and lenders (Ernst & Young 
2010, p.16). Specifically, they find that more than 90% of financial statements’ users 
included in their survey utilize impairment information disclosed in financial statements 
in their investment or lending decision-making process, with 66% of respondents finding 
impairment disclosures useful in making decisions to buy, hold, or sell assets. Appendix 
B provides an example on impairment disclosures for 
PPE
(non-current assets) in the 
annual reports of two UK firms reporting under UK GAAP in 2004 (Panel A) and under 
IFRS
in 2006 (Panel B). Under UK GAAP, neither firm disclosed the impairment testing 
procedures. However, under 
IFRS
, both firms have detailed description of the impairment 
testing procedures in the notes to the financial statements.
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14
A cash-generating unit (GCU) is the smallest identifiable group of assets that generates cash inflows that 
are largely independent of the cash inflows from other assets or groups of assets. If it is not possible to 
estimate the impairment loss of the individual asset, an entity shall determine the recoverable amount of the 
GCU to which the asset belongs (IAS 36). 
15
Based on my review of the annual reports for UK firms, I can say that the two examples in Appendix B 
reflect the overall level of disclosure for impairment testing related to 
PPE
in the annual reports of most 
UK firms in my sample. 

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Prior studies (e.g., Barth et al. 2012; DeFond et al. 2010; Yu 2010) show that 
mandating 
IFRS
, a uniform set of accounting standards, improves accounting information 
comparability among firms from different countries. Hence, given that EU firms are 
subject to the same standard for impairment testing after 
IFRS
mandatory adoption, 
impairment testing is more comparable among those firms. Consequently, it can be 
argued that EU firms have less discretion in measuring and reporting impairment losses. 
Collectively, the arguments noted above and summarized in Table C1 suggest that 
IFRS
has more informative, more transparent, and more comparable impairment rules (i.e., 
strict impairment rules) for 
PPE
relative to EU countries’ domestic GAAP that had less 
informative, less transparent, and less comparable impairment rules (i.e., loose 
impairment rules).
While 
IFRS
allows firms the option of using fair-value accounting for 
PPE
, 
studies show that most EU firms use historical cost accounting with impairment testing 
under 
IFRS
. For example, the Institute of Chartered Accountants in England and Wales 
(ICAEW), in its 2007 report to the European Commission about EU implementation of 
IFRS
and the fair-value directive, documents that “use of fair-value accounting under 
IFRS
is much less extensive than is sometimes assumed to be the case, and is in fact very 
limited overall.” In particular, they find that when there is a choice between a historical 
cost model and a fair-value model, firms typically choose a historical cost model. For a 
sample of UK and German firms, Christensen and Nikolaev (2010) find results consistent 
with the findings in ICAEW’s report. They find that, after 
IFRS
mandatory adoption in 
UK and Germany, most firms elected to use a historical cost model rather than a fair-
value model to measure non-financial assets. Further, among UK firms that had the 
option of using fair-value accounting for 
PPE
under UK GAAP, Christensen and 
Nikolaev (2010) find less fair-value accounting for 
PPE
under 
IFRS
than under UK 
GAAP. 

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