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.
11
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.
13
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).
14
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).
14
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.
15
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.
15
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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