Inco Ltd.: Market Value, Fair Value, and Management Discretion*

Abstract

This study examines management discretion in determining when and how much to write down impaired assets under generally accepted accounting principles (GAAP). Current U.S. GAAP identify an asset as impaired when its recorded value exceeds the amount at which a willing buyer and seller would transact, but allows a write-down only when the recorded value exceeds the sum of undiscounted cash flow. We examine a unique case where we can observe a separate market value for the impaired long-term asset for the majority of the period from its purchase to its write-down. Inco, a multinational nickel mining company, wrote off a substantial portion of the value of its project at Voisey's Bay (VB), Labrador, Canada in 2002. At acquisition in 1996, the company had issued a tracking stock tied only to the value of VB, which it retired in 2000. We use the tracking stock value and cash flow estimates to construct a valuation model, which we then employ to value VB in the 2000-2002 period. We find that (1) relative to market value, the assets were substantially overvalued on the financial statements for most of the period 1996-2000, yet no revaluation occurred until 2002; (2) US GAAP should have prohibited a write-down, despite substantial overvaluation, even in 2002; and (3) the 2002 write-down amount is inconsistent with parameters the market had been using to value VB. Our study raises questions regarding the discretion inherent in the timing and valuation of long-term asset impairment charges, the accounting standards that govern these valuations, and enforcement of these standards.