An evaluation of asset impairment decisions by Australian firms and whether this was impacted by AASB 136

Transcription

1 An evaluation of asset impairment decisions by Australian firms and whether this was impacted by AASB 136 David Bond, Brett Govendir and Peter Wells Accounting Discipline Group, University of Technology Sydney Abstract Focussing on asset impairments recognised in financial reports, this paper evaluates how managers of Australian firms are implementing the relevant regulation. This is undertaken both before and after transition to IFRS to provide insights into whether the prescriptive requirements of AASB 136 (IAS 36) impacted the recognition of asset impairments. Evidence is provided that the incidence of asset impairments increased significantly for firms where there were indicators of impairment subsequent to the transition to IFRS. However, the majority of such firms are still not recognising impairments, and in most cases the asset impairments recognised are not material or not of a magnitude suggested by the indicators of impairment. This suggests there are potentially issues with either compliance with the regulation or that additional disclosures are necessary for firms not making asset impairment. Key words : Impairment of assets, AASB 136 JEL Classification : M41, G32 1

2 1. Introduction The objective of this paper is to evaluate the implementation of asset impairment regulation by managers of Australian firms through an examination of asset impairment recognised in financial reports. This is undertaken between 2000 and 2012 which includes both the period when the requirement for asset impairment was addressed by AASB1010 Recoverable amount of non-current assets, and subsequent to transition to International Financial Reporting Standards (IFRS) when it was addressed by AASB 136 Impairment of assets. 1 Of particular concern is whether there is evidence of firms implementing the regulation requiring the recognition of asset impairment in manner which is consistent with the economic circumstances, financial performance and asset values of the firm. Furthermore, are the regulations being complied with and is information being disclosed which would be expected to reduce uncertainty about firm value? Additionally, did the recognition of asset impairment change with transition to IFRS and the implementation of AASB 136 which is much more prescriptive in the measurement of recoverable amount and is central to the determination of asset impairment? The primary motivation for this paper is to enhance our understanding of the recognition of asset impairment by Australian firms, and the extent to which this is consistent with the regulations requiring asset impairment. This is important as there are a number of high profile firms which ostensibly should have recognised asset impairments, and this was either considerably delayed or has not occurred and there are scant disclosures of why. 2 For example, Qantas Ltd had a market value per share substantially less than book value for 5 years, by as much as 50%. This persisted from 2009 until 2013, a period where profitability and operating cash flows were at best marginal and these would all be considered indicators 1 The Australian equivalents to IFRS were required to be adopted for financial years beginning on or after 1 January For most firms with 30 June year ends, 30 June 2006 was the first year of applying the Australian equivalents to IFRS. Hence in the interests of simplicity we will refer to 2006 onwards as the IFRS period, although it does include 31 December 2005 year ends. 2 There is no evidence the disclosures resulted in lowering the gap between book value and market value. 2

3 of impairment. In 2014 an impairment of $2.947b was recognised and there was finally an alignment of book value with market value. Similarly, Fairfax Media Ltd reported poor financial performance and a book value significantly in excess of market value for a number of years before it recognised an asset impairment of $2.865b in its 30 June 2012 financial report. Only after years with a book value considerably less than market value was there finally an asset impairment and book value consistent with market value. While the above firms eventually recognised an asset impairment, Seven West Media Ltd has had a market-tobook value of substantially less than one since 2011, and it is presently This has not been the catalyst for asset impairments and there have been scant disclosures to support the decision not to impair assets, other than to say that the regulation was complied with (i.e., trust me). Concerns with how the regulation requiring asset impairment is being implemented have also been expressed recently by the Australian Securities and Investments Commission (ASIC), and they note problems with the mismatching of cash flows, the reasonableness of cash flow assumptions, the identification of cash generating units and disclosure. 3 However, ASIC concerns are largely driven by anecdotal evidence rather than systematic empirical analysis. This suggests an analysis of the financial statements of firms where asset impairment is expected to provide insight into how the regulation is being implemented and asset impairments recognised. A second motivation for this study is to evaluate the impact of differences in the style of regulation on its implementation. With transition to IFRS and the implementation of AASB 136, the regulation requiring asset impairment while maintaining the same concepts was much more prescriptive in the measurement of recoverable amount, and hence the determination of asset impairments. Critically, did this impact the implementation of the 3 ASIC Media Release ASIC s area of focus for 30 June 2013 financial reports. 3

4 regulation and change the recognition of asset impairments? This is relevant for regulators who may be concerned with how regulatory style impacts the implementation of regulation. This paper complements a growing stream of research which evaluates asset impairment. Asset impairment decisions have been the subject of extensive investigation internationally (e.g., Riedl 2004; Jarva 2009) as well as in Australia (e.g., Cotter, Stokes and Wyatt 1998). However, this research has generally focused on the identification of opportunistic motivations impacting the recognition of asset impairments. The implementation of AASB 136 has also been considered with respect to the impairment of goodwill, and in particular the discount rates used and disclosed (e.g., Carlin and Finch 2009; Bradbury 2010). However, the issue of how the regulation is being implemented more generally has received little attention. Accordingly, this paper contributes to the asset impairment literature and provides insights into whether the presence of external indicators of impairment is manifesting in recognised asset impairment as required by the regulation. This is of concern to standard setters, financial market regulators, auditors and financial statement users alike. From a sample of 5,839 Australian firm-years between 2000 and 2012 we find that there are 543 (29%) firm-years where asset impairments is recognised, with the impact on the book value of the firm generally being immaterial. Within this sample there are 1,857 firmyears (32%) that report at least one external indicator of impairment (i.e., book value exceeding market value). Furthermore, for this subsample the majority reported poor performance, suggesting more indicators of impairment are present. However, only 242 of these firm years (13%) recognised asset impairment. There is some evidence that this increased with the application of the more prescriptive requirements of AASB 136, but the association between asset impairment and indicators of impairment remains weak. The first contribution of this paper is that there is little evidence that firms are complying with the 4

5 regulatory requirements for recognising asset impairment, and there are limited disclosures required where firms do not recognise asset impairment.increased disclosures might be considered by regulators and through this greater attention directed at the decision by the firm not to impair assets. The second contribution of this paper is to suggest a review of the disclosure requirements for firms recognising asset impairments to consider either the nature of the information disclosed, or whether they extended beyond the cash generating unit where the impairment is recognised which may be limiting the present disclosures. Of the 543 firm-years where asset impairment is recognised, only 158 (29%) include an impairment of goodwill. This is a consequence of the number of cash generating units in the firms and how goodwill is allocated across the cash generating units. The third contribution of this paper is to identify a limitation of the papers that consider impairment of goodwill only, and that the impairment of assets should be considered more generally. Given the focus on goodwill impairments in many studies and the subjectivity of goodwill valuation, the strong findings for opportunistically motivated assets impairment are probably expected. For the firms recognising asset impairment only 242 (45%) had a book value greater than market value. A final contribution of this study is that the evaluation of asset impairments is problematic as impairment decisions are evaluated at the cash generating unit level and this may be obscured in aggregate firm level information. The remainder of the paper is organised as follows. In the following section an overview of the regulation and prior research into asset impairment are introduced. From this hypotheses are developed. In Section 3, the research design is described and in Section 4 the sample selection procedure and some preliminary descriptive statistics are provided. Section 5 sets out the main results of the analysis regarding asset impairment. Finally, the conclusions are presented in Section 6. 5

6 2. Regulatory background and theory development 2.1 Regulatory Background Since 2000 there has been a regulatory requirement in Australia for non-current assets to be recognised at no more than recoverable amount. In the period immediately prior to transition to IFRS this was addressed by AASB 1010 Recoverable amount of non-current assets and when this standard was issued in 2000 there was the intention that it should be in general conformity with IAS 36 as it was issued in This was reflective of a broad strategy of convergence being followed at the time by the Australian Accounting Standards Board (AASB) 4 and this is evidenced by the terminology used. This includes the use of the term recoverable amount and the stated requirement for an asset to be written down to its recoverable amount when the carrying amount is greater than recoverable amount (para 5.2). However, recoverable amount was not precisely defined, and merely described as the net amount of cash flows expected to be recovered from disposal and continued use of assets together. Little explanation was provided for how this should be determined. Nor was the discounting of cash flows specifically addressed, and there were anecdotes of net cash flows not being discounted. With transition to IFRS the requirements for asset impairment prescribed in IAS 36 were replicated in AASB 136 Impairment of assets, and in contrast to the prior standard it was highly prescriptive of how decisions on asset impairment should be made, how recoverable amount is measured and hence how asset impairment should be determined. In terms of the volume of regulation, there are 40 paragraphs addressing the determination of 4 See Policy Statement 6 International Harmonisation Policy issued by the AASB and PSASB in

7 recoverable amount, and of these 28 paragraphs address the estimation of value in use. It included detailed requirements that where there are indicators of impairment such as significant decline in firm value, significant changes in in technology, market, economic or legal environments, changes in market interest rates, asset obsolescence or changes in asset utilisation, firms should undertake impairment testing (AASB 136, para 12). Impairment testing requires the determination of the recoverable amount of the asset, which is defined as the higher of fair value or value in use (AASB 136, para 6). For some assets where fair value is observable in an active market this will be relatively straightforward. For some assets it will be much more problematic and value in use will have to be estimated. Again, guidance is provided describing the procedures for estimating future cash flows and discounts rates (IAS 36, para 30). Impairment testing involves the comparison of carrying value with recoverable amount, and impairment is required to ensure that carrying value does not exceed recoverable amount (AASB 136, para 59). When implementing AASB 136 it will often be applied to groups of assets, referred to as cash generating units, rather than individual assets. However, a process consistent with that outlined above is applied to the cash generating unit, and an order is prescribed for the impairment of assets within a group. Goodwill within a cash generating unit is impaired first, and then subject to conditions the remaining assets are impaired on a pro-rata basis (AASB 136, para 104). This creates a number of issues when evaluating asset impairment if there is more than one cash generating unit within a business. First, determination of whether asset impairment is required may not always be possible from aggregate firm level information. 5 Where firm market value exceeds book value it is possible that there will be no cash generating units where recoverable amount is less that carrying amount and no impairment is necessary. However, there may be individual 5 This would require information about the relative size and loss of value within the separate cash generating units which is not disclosed. 7

8 cash generating units where recoverable amount is less than carrying amount. Accordingly, impairment may be necessary notwithstanding there being no externally identifiable indicators. 6 Where aggregate firm level recoverable amount is less than carrying amount, it is expected that there will be at least one cash generating unit where recoverable amount is less than carrying amount and impairment will be necessary. In this study the focus is on how firms are implementing the regulation, so while considering all firms, particular attention is focussed on those where market value is less than book value (an indicator of impairment, AASB 136, para 12(d)) and an impairment decision is necessary. Second, whether impairment within a cash generating unit is applied to goodwill or other assets will depend on the allocation of goodwill across the cash generating units of the firm. If no goodwill has been allocated to the cash generating unit for which impairment is required, assets other than goodwill will be subjected to impairment. This is an issue for studies that evaluate impairment of goodwill only (e.g., Ramanna and Watts 2012) and it is for this reason that the focus is on impairment generally rather than goodwill alone. 7 Critically, how this regulation is being implemented and whether asset impairment is recognised, where necessary, is a major concern for standard setters, financial market regulators and financial statement users. Furthermore, with transition to IFRS and the adoption more prescriptive approach taken to the measurement of recoverable amount, was there a change in the recognition of asset impairment? 2.2 Empirical research There is a significant literature evaluating asset impairment. This has considered the incidence of asset impairment (e.g., Strong and Meyer 1987) and there is evidence that asset 6 Consistent with this we observe that 301 observations where asset impairments are recognised (55% of those recognising asset impairments) arise where market value exceeds book value. 7 In this regard we note that in our sample of firms recognising impairment, only 158 (29%) are impairing goodwill. Most asset impairments relate to tangible assets (69%). 8

9 impairment is associated firm economic characteristics and performance (e.g., Cotter et al. 1998). However, evidence on price reactions to asset impairment is mixed and this has been attributed to the nature of the assets being impaired and concerns about timeliness in the recognition of asset impairment (e.g., Francis, Hanna and Vincent 1996; Collins and Henning 2004; Jarva 2009; Muller, Neamtiu and Riedl 2010). The determination of asset impairment requires the exercise of considerable discretion and hence many studies consider whether they are opportunistically motivated (e.g., Elliott and Shaw 1988; Francis et al. 1996; Cotter et al. 1998; Riedl 2004; Beatty and Weber 2006; Christensen, Paik and Stice 2008; Garrod, Kosi and Valentincic 2008; Jarva 2009, 2014). Results are consistent across different countries and regulatory environments and suggest asset impairment is opportunistically motivated. Furthermore, there is evidence that effective corporate governance mechanisms may constrain opportunism (e.g., AbuGhazaleh, Al-Hares and Roberts 2011). 8 In many of these studies controls are included for firm performance and this includes many factors that would in terms of the current regulation be labelled as indicators of impairment. However, this is not the focus of these prior studies and the relevance of these factors to the recognition of asset impairment has received scant separate consideration. Furthermore, sample firms have been broadly selected. This reflects concerns with identifying the association between asset impairment and opportunistic motivations, rather than the extent to which asset impairment is consistent with the requirements of the relevant regulation. Hence, the focus of this study is whether there is evidence that financial statements are being prepared in a manner consistent with the requirements of AASB 136, and whether firms are recognising asset impairment where this is suggested by the presence 8 Much of this literature focuses on goodwill impairment as it is motivated by how SFAS 142 Goodwill and other intangible assets was implemented, and how it impacted reporting behaviour. Notwithstanding, there are exceptions such as AbuGhazaleh et al. (2011). 9

10 of indicators of impairment. 9 This is considered important as the asset impairment recognised, and the accompanying disclosures would provide information about expected future performance and future cash flows. This would lead to lower parameter uncertainty in estimating firm value (Lewellen and Shanken 2002; PÁstor and Pietro 2003) and reduce uncertainty about firm value in the same manner as management earnings forecasts (Rogers, Skinner and Van Buskirk 2009). As discussed in section 2.1, between 2000 and 2012 there was a requirement for firms to recognise asset impairment where the carrying amount of assets exceeded the recoverable amount of the asset. This was addressed in the period prior to transition to IFRS by AASB 1010, and subsequent to transition with AASB 136. The initial concern in this paper is whether there is evidence that for firms recognised asset impairment in a manner consistent with the regulation. This is reflected in the following hypothesis. H 1 : Is evidence that firms are recognising asset impairment where there are indicators of impairment. The second concern of this paper is whether the nature of the regulation impacted its application. As discussed in section 2.1 there was considerable discretion in the application of AASB 1010 and this is in stark contrast with the requirements of AASB 136 which would be considered detailed and prescriptive. While regulators might argue that this is likely to increase compliance with regulatory intent, the actual impact is less certain. Shaw (1995) and Beresford (1999) both express concerns about whether practitioners are able to critically understand and apply complex regulations, which are likely to contribute to standards overload. These concerns are echoed by Bonner (1994) in relation to auditors. She suggests that more complex tasks, or in this case regulations, are likely to adversely impact auditors judgement performance and this likely 9 This should be distinguished from where firms are recognising impairment, or excessive impairment for entirely opportunistic reasons. 10

11 reflects an increasing concern with strict regulatory compliance at the expense of the exercise of professional judgment. This conclusion is supported by Bennett, Bradbury and Prangnell (2006) who, based on an analysis of specific regulation, find that more prescriptive regulations require less professional judgement. It is therefore not surprising that Nelson, Elliott and TarpIey (2002) provide evidence that managers are more (less) likely to attempt earnings management, and auditors are less (more) likely to constrain it, where accounting regulations are more (less) precise and earnings management actions can be structured to demonstrate compliance with the regulation. This suggests that the change in the regulation relating to asset impairment with transition to IFRS, and the adoption of a more prescriptive regulation, may not have led to greater adherence to the intent of the regulators. We test the following hypothesis to determine if there was a change in the recognition of asset impairments across the two regulatory regimes. H 2 : With the adoption of a more prescriptive regulation there was an increase in the recognition of asset impairment by firms where there is evidence that asset impairment decisions are necessary. 3. Research design The primary concern in this paper is whether there is evidence of firms recognising asset impairment in response to deteriorating economic circumstances, financial performance and asset values in accordance with the requirements of the regulation. This is reflected in the research design. The determination of asset impairment requires the exercise of judgement by management, but as a safeguard against over-optimism the regulation identifies detailed indicators of impairment and if any of these are present impairment testing is required to be 11

12 undertaken (AASB 136, para 12, IAS 36 BCZ24). This would be expected to lead to asset impairment being recognised. While these indicators are not explicitly identified in AASB 1010, they would have been equally relevant to the determination of whether impairment is necessary and they are included in the initial version of IAS 36 (issued in 1998) which would have been considered authoritative. Accordingly, these factors will be used to identify firms where impairment is likely necessary, and the extent to which impairment is necessary. While primarily concerned with evaluating how firms are implementing the regulation, it is recognised that financial reports are a joint statement of management and auditors (Antle and Nalebuff 1991, p. 31). Auditors are a source of accounting expertise and will review critical accounting decisions, such as impairment testing. Hence consideration is also given to how auditors impact the recognition of asset impairment, but this is on the basis of their direct involvement in the financial reporting process rather than as a corporate governance mechanism. This suggests the estimation of the following model to evaluate how the regulation prescribing asset impairment is being implemented: Impair it = B/M it + 2 Yrs it + 3 Earn it + 4 CF it + 5 BHR it + 6 AuditQual it + 7 AuditEff it + ε it (1) To determine whether the recognition of asset impairment changed across the regulatory periods, equation (1) is re-estimated with an indicator variable to distinguish the two regulatory periods to capture any change in impairments generally, and with interaction terms to capture changes in the extent to which there is a change in the extent to which any of the indicators of impairment are deterministic of asset impairment. 12

13 Impair it = β 0 + β 1 B/M it + β 2 Yrs it + β 3 Earn it + β 4 CF it + β 5 BHR it + β 6 AuditQual it +β 7 AuditEff it + ε it (2) And: Impair it = β 0 + β 1 B/M it + β 2 Yrs it + β 3 Earn it + β 4 CF it + β 5 BHR it + β 6 AuditQual it +β 7 AuditEff it + β 8 IFRS it + β 9 B/M it IFRS it + β 10 Yrs it IFRS it + β 11 Earn it IFRS it + β 12 CF it IFRS it + β 13 BHR it IFRS it + β 14 AuditQual it IFRS it + β 15 AuditEff it IFRS it + ε it (3) The variables in these regressions are measured as follows. Impair The focus of this paper is the incidence of asset impairment (Impair) and this is measured in the first instance as continuous variable being the asset impairment per share recognised in the income statement in accordance with the disclosure requirements of AASB 136. Recognising that indicators of impairment may lead to asset impairment but the magnitude of the asset impairment may be highly variable, as a sensitivity the analysis is undertaken with Impair measured as a dichotomous variable. As impairments are negatively signed, to ensure consistency in the results from regressions with the continuous variable, this assumes the value 0 if an asset impairment is recognised, otherwise 1. Indicators of Impairment The initial concern in this study is whether the presence of indicators of impairment is associated with the recognition of asset impairment. Consistent with the requirements of the 13

14 regulation we identify external factors which are indicators of impairment, and which externally observable. A book value in excess of market value is an indicator that the market has determined that the value of assets is less than book value (AASB 136, para 12(d)). Hence B/M is included as an independent variable and is measured as the ratio of the book value of equity over the market value of equity at the end of the financial year. This is included as a continuous variable as the greater the excess the stronger the indication that an asset impairment should be recognised. If book value has been greater than market value for more than one year this suggests that the decline in value that the firm has experienced is not transitory. Hence, Yrs is included in the regression and this is a dichotomous variable assuming the value one if B/M has been greater than one for two years (current and preceding), and zero otherwise. An increase in the B/M may have occurred because of a substantial decline in market value, however this may not have resulted in a value greater than one. There may be individual cash generating units to which the decline in market value can be attributed and this doubtless contributed to the identification of declines in market value as an indicator of impairment (AASB 136, para 12(a)). Therefore, we complement B/M with BHR, which is the buy-hold return for the stock over the financial year, as a further indicator of impairment. Other indicators of impairment may be observable internally during the financial year, and these would become observable externally at year end when the financial statements are prepared. Where economic performance of an asset is worse than expected asset impairment is necessary (AASB 136, para 12(g)). Evidence of this would include actual cash flows and profitability being worse than expected (AASB 136, para 14(b)-(d)). Accordingly, we include earnings before impairment charges per share (Earn) and aggregate cash flow from operating and investing per share (CF) as further indicators of impairment. 14

15 Audit Recognising that audit quality may be relevant to decisions relating to the implementation of the regulation we include AuditQual as an independent variable which assumes the value one if the firm is audited by a Big 4 auditor, and zero otherwise. Evaluating impairment decisions may also impact the requisite audit effort and hence we in AuditEff as an independent variable measured as the percentage change in audit fees for the firm. Regulatory change With the change in regulation on transition to IFRS this may have changed the incidence of asset impairments. To evaluate this we consider differences in the magnitude or frequency of asset impairment (reflecting the dependent variable used) by including a dichotomous variable, IFRS, which has the value one if the financial reports are from the post-transition period (i.e., prepared under AASB 136) and zero otherwise. This variable is also interacted with the other independent variable to determine whether there any changes in the association with those variables and asset impairment in the post-transition period. 4. Sample selection and data description Sample observations for this paper were chosen in the first instance between 2000 and 2012 so as to include firm-years from periods both before and after the adoption of IFRS in Australia. Financial report information was obtained from the Morningstar Datanalysis database, stock price information was obtained from SIRCA SPPR database and audit data was obtained from the UTS Audit database. Financial information was supplemented where necessary with hand collected information from financial reports where asset impairments 15

16 were potentially aggregated in abnormal items in the Morningstar database. Firms in the agriculture, financial services, real-estate investment sectors were excluded because changes in asset values may not be recognised as impairment due to the application of fair value accounting (e.g., AASB 140 Investment Property; AASB 141 Agriculture). While there is provision in other standards such as AASB 116 Property Plant and Equipment and AASB 138 Intangible Assets for the recognition of assets at other than cost (i.e., the revaluation model), in practice very few firms avail of this choice and it is reasonable to assume that remaining firms have significant assets recognised at cost and for which AASB 136 Impairment of Assets would be relevant. 10 This ensured that sample firm-years are more likely to be recognising assets at cost and decrements in asset value would be recognised as impairment in accordance with AASB 136 Impairment of Assets or an equivalent. This identified a final sample of 5,839 firm year observations where all necessary information was available. Descriptive statistics for sample firms are provided in Table 1. This shows that for the full sample of firms the mean (median) book value of equity per share was $1.279 (0.424), and the mean (median) of stock price was $0.977 (0.663). The mean asset impairment was $0.010 per share and this represents less than 0.4% of mean total assets. Doubtless influencing this is limited number of firms recognising asset impairments, with only 543 firms (9.3%) of firms recognising asset impairment. For firms recognising asset impairment, mean impairment is $ Of the firms recognising asset impairment, 158 firms recognised an impairment of goodwill, while 196 recognised an impairment of an identifiable intangible asset and 374 recognised an impairment of tangible assets. This reaffirms the decision to address asset impairment generally rather than focus on goodwill in particular, and suggests 10 Asset impairments could be recognised for assets measured at fair value between the years where revaluation is undertaken. Accordingly, changes in asset values may be recognised as both impairments and revaluations. However, these circumstances are rare and unlikely to influence the results. 16

17 that studies focusing on goodwill impairment may be missing a significant proportion of impairments. 5. Results To provide insights into the full extent of the recognition of asset impairments we provide descriptive statistics for the full sample in Table 1. For these firm year observations the mean (median) B/P ratio is (0.663) and this indicates considerable skewness in the distribution of this variable. This is confirmed by the 75 th percentile being 1.187, and there are a significant number of firms with a B/P ratio of greater than one and for which asset impairment is ostensibly an accounting issue. We identify 543 (9.3%) firm-year observations where asset impairments are being recognised, and for these firms the mean (median) impairment per share is (-0.026). Again this identifies considerable skewness and most asset impairments are economically small. Of the firm-years where asset impairment is recognised, 158 (29%) include an impairment of goodwill, while 196 include impairment of identifiable intangible assets and 374 impairment of tangible assets. This confirms the concerns expressed above about focussing on goodwill impairments only, and assuming the goodwill is allocated to the cash generating units where impairment is required to be recognised. In Table 2 attention is directed at firms where the firm has a book value greater than market value (B/P>1). This is undertaken to focus attention of firms where there is at least one indicator that impairment is necessary. This identifies 1857 firm-year observations (32% of the full sample) with a book value in excess of market value. Furthermore, for these firms it is also notable that while the mean values of earnings per share and cash flows per share (CFOPS+CFINV) are and respectively, the median values were economically little different from zero. Accordingly, for a majority of this subsample the existence of 17

18 indicators of impairment is likely not limited to book value being greater than market value. Hence, it is somewhat surprising that only 242 (13%) of these firms-year observations are recognising asset impairment, there is little support for H 1. Of these impairments, only 85 (35%) include an impairment of goodwill and this highlights the problem of assuming goodwill is allocated across the cash generating units where impairments are being recognised. For firms-years where asset impairment is recognised (Panel B) it is clear that while some firms are recognising material impairments and the mean impairment per share is , most asset impairment is relatively small and the median asset impairment per share is only Whether this is sufficient, or commensurate with the indicators of impairment will be addressed in the subsequent analysis. In combination these tables suggest that the incidence of asset impairment is relatively low, and this is particularly so for firm-years where there is at least one indicator of impairment. Furthermore, the magnitude of recognised asset impairment is low, and the majority are economically immaterial. This initial analysis provides little support for H 1. To provide further insight into the nature of firm-years with at least one indicator of impairment we further partitioned them on the basis of size, with the results presented in Table 3. This reflected concerns that smaller firms may not be subject to the same level of scrutiny and this may impact the results. Included in our subsample of firm-years there are 1,212 firm-years with a market capitalisation of greater than $10m and 197 (16%) of these firms recognised an asset impairment (Panel A). This contrasts with only 45 (7%) of firmyears with a capitalisation below $10m recognising an asset impairment. This may be a consequence of smaller firms being subjected to less scrutiny by directors, auditors, regulators and investors. It is also notable that firm performance, measured as earnings and cash flows are poorer for smaller firms, but the median values of earnings and cash flow for the larger firms indicates that the majority of the larger firms are still experiencing poor 18

19 performance. Hence, while there is evidence of more asset impairment is being recognised by larger firms, concerns about lack of recognition of asset impairment persist for all firms. Recognising the regulatory change that occurred in 2006, firm-years were partitioned on the basis of whether the historic Australian regulation applied (i.e., ASB 1010) or whether the post transition to international accounting regulations applied (i.e., AASB 136). The sample includes more firms from the post-transition period (1,137 compared to 720), and there was proportionately greater recognition of asset impairment in the post-transition period (195 or 17% compared to 47 or 7%). However, it is notable that there are still less firms recognising asset impairment than would otherwise be expected given presence of indicators of impairment. Again, there is little support for H 1. To evaluate the association between impairment and indicators of impairment, equation 1 was estimated with the results presented in Table 5. Focusing initially on impairment measured as a continuous variable (Panel A) and firm-years where the book value is greater than market value (and firms most likely need to undertake impairment testing and recognise asset impairments) it is notable that the model has an adjusted R 2 of 15.2%. While this is statistically significant given the regulatory prescription there is an expectation this might be greater. The co-efficient on the indicators of impairment are generally as expected given that impairment is negatively signed. While B/P is not significant this is likely a consequence of firms already being partitioned on the basis of B/P. The coefficient on YRS (α 2 =-0.092, t-stat=-3.326) is negative and significant while the co-efficient on Earn is positive and significant (α 3 =0.595, t-stat=18.343) suggesting that the magnitude of impairment is greater if book value has been greater than market value for two years and if the firms is less profitable. The co-efficient on CF is not significant and this is likely a consequence of this measure being confounded by higher investing cash flows where firms are able to raise debt and equity to finance asset acquisition. Finally the co-efficient on BHR 19

20 is negative and significant (α 5 =-0.090, t-stat=-3.498) and while surprising this may simply reflect a poor stock return not being an indicator of impairment if it follows historic high market values and high profitability. When the equation was estimated for the full sample of firms the model lost explanatory power and this would have been adversely impacted by difficulties assessing asset impairments in cash generating units on the basis of aggregate firm level information. The results when impairment is measured as a dichotomous variable are presented in Panel B. For both the B/P>1 subsample and the full sample the model has minimal explanatory power (2.1% and 2.2% respectively). For both samples the decline in explanatory power is consistent with the limited number of material asset impairments receiving less weight in the analysis (and many asset impairments recognised being small), together with a high proportion of firm-years where there are indicators of impairment but asset impairment is not recognised. Furthermore, when the full sample is considered many of the co-efficients have a different sign from that expected and this is likely a consequence of the high proportion of firms recognising asset impairment within a cash generating unit when there are no aggregate firm level indicators of impairment. It is also notable that the co-efficient on AuditQual Changes between Panels A and B and this suggests that Big 4 auditors are more likely to require a large impairment where necessary, but generally their clients are larger, more profitable and less likely to need to make an asset impairment. In summary the results for tests of hypothesis one are weak and while there is some evidence that firms with indicators of impairment are recognising asset impairment, this is not pervasive and many are recognising either small impairments which are not commensurate with the magnitude of the indicators of impairments or not recognising asset impairment. This result is consistent with extant literature which provides strong evidence of opportunistic incentives being a major determinant of asset impairments (e.g., Elliott and 20

21 Shaw 1988; Francis et al. 1996; Cotter et al. 1998; Riedl 2004; Beatty and Weber 2006; Christensen et al. 2008; Garrod et al. 2008; Jarva 2009, 2014). Further weakening these tests are the number of firms recognising impairment where there is no externally identifiable indicator of impairment at the aggregate firm level. Finally, the proportion of firms recognising impairment of goodwill is relatively low, and this is inconsistent being distributed across all cash generating units as is assumed in many impairment studies. In Table 6 we commence our evaluation of whether there are differences in the recognition of asset impairment subsequent to the transition to IFRS and the implementation of AASB 136, and this is undertaken with the inclusion of an indicator variable, IFRS. In Panel A asset impairment is measured as a continuous variable and the results are little changed from those in Table 5. Critically, for the subsample where book value exceeds market value the co-efficient on IFRS is not significant (α? =0.023, t-stat=0.792), and for the full sample the model has literally no explanatory power. These results contrast with those in Panel B where asset impairment was measured as dichotomous variable, and for both the samples of firms the coefficient on IFRS was negative and significant which is indicative of a greater incidence of impairments subsequent to the transition to IFRS and more prescriptive regulations. This result complements those provided in Table 5 and suggests that both before and after transition to IFRS and more prescriptive regulations some firms recognised economically material asset impairment. However, subsequent to transition to impairment there was an increased incidence of small asset impairment which may not have been commensurate with the indicators of impairment observed. Furthermore, many firms with indicators of impairment are not recognising asset impairments. Hence, there is at best limited support for H 2, in that while there may have been an increase in the recognition of asset impairment, they may not have been fully reflective of the economic circumstances. 21

22 Finally, in Table 7 we consider whether there was a change in the relation between the recognition of asset impairment and the various indicators of impairment in the post-ifrs period. The results across Panels A (continuous) and B (dichotomous) and for the sample with book value greater than market value and the full sample provide few additional insights. First, the models have poorer than expected explanatory due to the low incidence of firm-years recognising impairment where there are indicators, and firms recognising impairment where there are no externally observable indicators. Second, a significant proportion of the asset impairment recognised is economically insignificant. In combination this causes considerable instability on the regression results, including co-efficients not being significant or changing sign across the different regressions. Accordingly, while there may have been an increased recognition of asset impairment subsequent to transition to IFRS, the associations with indicators of impairment are still tenuous and there is again little support for H Conclusion The objective of this paper was to evaluate how the regulation prescribing asset impairment is being implemented by managers through an examination of asset impairment being recognised in financial reports. Of particular concern was whether evidence could be found that the regulations are being complied with and whether information about expected future performance and future cash flows is being provided through the recognition of asset impairment and the associated disclosures. Furthermore, did this result change with transition to IFRS and implementation of the more prescriptive AASB 136. We provide evidence that for 1,857 (32%) of our sample firms book value exceeds market value and there is at least one indicator of impairment. For these same firms there is also evidence of poor performance with reported earnings and cash flows being economically 22

23 immaterial for the majority of these firms. Furthermore, for many firms these circumstances persisted for a number of years. However, only 242 (13%) recognised asset impairment and the association of asset impairment with indicators of impairment is weak. There is some evidence that this improved with the more prescriptive requirements of AASB 136 but the association between asset impairments and indicators of impairment remains weak. Hence, the first contribution of this paper is that there is little evidence that firms are complying with the regulatory requirements for recognising asset impairment. Problematically, where there are external indicators of impairment present but asset impairment is not recognised, the mandated disclosures are minimal. Given the proportion of firms in this circumstance, regulators might consider increased disclosure for firms not impairing assets thereby directing greater attention at the decision by the firm not to impair assets. The majority of asset impairments recognised are economically immaterial, and the association with indicators of impairment is weaker than would be expected. The second contribution of this paper is to suggest a review of the disclosure requirements for firms recognising asset impairment to consider either the nature of the information disclosed or whether the disclosures are extended beyond the cash generating unit where the impairment is recognised. Of the 543 firm-years where asset impairment is recognised, only 158 (29%) include an impairment of goodwill. This is a consequence of the number of cash generating units in the firm and how goodwill is allocated across the cash generating units. The third contribution of this paper is to identify a limitation of the papers that consider impairment of goodwill only, and that the impairment of assets should be considered more generally. Given the focus on goodwill impairment in many studies, the strong findings for opportunistically motivated asset impairment is probably expected. For the firms recognising asset impairment only 242 (45%) had a book value greater than market value. A final contribution of this study is that 23

24 the evaluation of asset impairment is problematic as impairments are evaluated at the cash generating unit level and this may be obscured in aggregate firm level information. Not addressed in this study, but which might be considered in future studies is how investors respond to asset impairment decisions and what evidence is there of share price and market impacts. 24

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