Asset Impairment and Earnings Management: Influence of Audit Quality

Abstract

Portuguese listed fi rms (as well as all EU companies) have been required to use IFRS and consequently IAS 36 – ‘Impairment of Assets’ – since 2005. Therefore, this paper examines empirically the effects of IAS 36 on asset impairment reporting, investigating whether IAS 36 reduces the magnitude and restricts the timing of reporting asset impairment. Additionally, we also analyse the influence of audit quality on the use of the asset impairment test as a tool to manage earnings. We use an OLS regression model to examine the effect of the asset impairment on earnings management for a sample of 33 nonfinancial-listed Portuguese companies from 2002 to 2010. We find that IAS 36 does not affect the magnitude of the reported asset impairment. Additionally, the results suggest that impairment fi rms are engaging in either ‘big bath’ or ‘income smoothing’ behaviour. Our findings also suggest that firms audited by Big 4 firms take significantly more impairments than firms audited by non-Big 4 firms. Furthermore, the results show that when there are incentives to underreport earnings, the likelihood of taking an asset impairment will increase more for firms audited by a non-Big 4 audit firm than for firms audited by a Big 4 audit firm. The findings based on this study provide useful information for the International Accounting Standards Board and other standard setters. The results also provide useful information to investors in evaluating the impact of IAS 36 on earnings quality.