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

4.1 Preliminary Results 
4.1.1 The Frequency of Impairment Losses for
PPE before and after IFRS Adoption
IFRS
has strict impairment rules for 
PPE
whereas domestic GAAP had loose 
impairment rules for 
PPE
. Among EU firms that elected to use historical cost accounting 
with strict impairment rules under 
IFRS
, I predict more impairment losses in earnings for 
PPE
following 
IFRS
adoption. Hence, in this sub-section, I examine the frequency of 
impairment losses (write-downs) for 
PPE
in the post-
IFRS
period relative to the pre-
IFRS
period. Impairment losses for 
PPE
are not available on WorldScope prior to 2002.
29
In 
order to obtain a balanced-sample in the pre- and post-
IFRS
periods, I remove years 2008 
and 2009 from the post-
IFRS
period.
30
Figure C1 presents the frequency of impairment 
losses for 
PPE
over the period 2002-2007 for my sample of 321 EU firms. During the 
pre-
IFRS
period (2002-2004), the total frequency of impairment losses was 136 (14% of 
firm-years). As predicted, during the post-
IFRS
period (2005-2007), the total frequency 
increased to 190 (20% of firm-years) for the same sample of firms and this increase is 
significant at the 1% level.
31
29
I define firms as recognizing impairment losses for 
PPE
if WorldScope reports a positive value in the 
field # 18274 (Impairment of Property, Plant & Equipment) in the ‘Supplementary Income Statement 
Fields.’
30
The removal of 2008 and 2009 from my analysis in this sub-section would also mitigate the effect of the 
economic downturn. The frequency of impairment losses for 
PPE
increased to 97 in 2008 and to 104 in 
2009. 
31
While there are more impairment losses after 
IFRS
mandatory adoption, the magnitude of these losses 
have decreased from an average of 1.2% of total assets during the pre-
IFRS
period (2002-2004) to an 
average of 0.5% of total assets during the post-
IFRS
period (2005-2007). This decrease in magnitude after 
IFRS
adoption is mainly driven by few firms reporting very large but infrequent losses during the pre-
IFRS
period. For example, one firm had impairment losses of 16.4% of total assets in 2002 but no impairment 
losses in any of the subsequent years. This result of having larger losses at a much lower rate in the pre-
IFRS
period relative to the post-
IFRS
period may indicate more big bath earnings management activities 
(i.e., lower-quality financial reporting) under domestic GAAP and, therefore, would suggest that managers 

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26 
The results in this sub-section indicate that using historical cost accounting with 
strict impairment rules under 
IFRS
led to a greater frequency of impairment losses for 
PPE
during the post-
IFRS
period relative to the pre-
IFRS
period. This finding is 
consistent with EU firms having more timely loss recognition for 
PPE
following 
IFRS
adoption and, consequently, more disciplinary implications on managerial investment 
decisions and stronger incentives for managers to reduce over-investment in 
PPE
. 
However, it is worth noting that the recognition of impairment losses does not capture the 
full disciplining effect that historical cost accounting with strict impairment rules has on 
managerial investment decisions. For example, a manager in 2006 knowing that 
impairment losses from losing investments will be reported in earnings in a more timely 
manner under historical cost accounting with strict impairment rules will more likely 
invest in positive NPV projects (i.e., reduce over-investment) and, hence, the firm may 
not recognize subsequent impairment losses over the period 2007-2009 on these projects 
if the newly acquired assets' discounted cash flows remain positive.