Evidence of Asset Impairment Reversals from China: Economic Reality or Earnings Management?

Abstract

Accounting practice for asset write-down reversals varies significantly among different countries. China is unique not only because such reversals are allowed without much restriction, but also because the disclosure of detailed reversal information is mandated. Based on a sample of reversal firms in China, we provide the following findings: First, although economic factors and reporting incentives both explain reversals, reporting incentives dominate managerial reversal decisions. Second, while total reversals provide investors with value-relevant information, the price-earnings multiples of this information are significantly weaker as compared to other income statement components. More importantly, we find that the valuation consequence of reversals, if unrealized, disappears completely. Third, impairment reversals negatively affect the association of accounting earnings with contemporaneous stock returns. Taken together, our results show that managerial opportunism may have reduced the reliability of otherwise value-relevant reversal information. While the intention of granting discretion in impairment reversal is for management to communicate private value recovery information, which reflects the essence of accrual accounting, our findings suggest that a high-quality accounting standard may not necessarily lead to high-quality accounting information.