The Effect of Reversibility on a Manager's Decision to Record Asset Impairments

Abstract

Abstract Over time, accounting standards have moved toward presenting more items at fair value on the balance sheet. Consistent with this trend, IAS No. 36 permits an impairment loss on a long‐lived asset to be reversed if the economic value of the asset recovers. This article uses empirical data from an experiment conducted with 118 managers to explore the implication of allowing impairment reversals on a manager's decision to record the loss. Results suggest that permitting reversals significantly increases the likelihood that a manager will record the impairment, especially if the manager has a bonus plan. The bonus plan effect is not caused by the manager's intention to smooth income through impairment reversals, but by his disutility from a bonus forgone if the value of the asset recovers but accounting rules prohibit him from reversing the loss.

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