Examining the impact of impairment upon the reported financial statements

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  1. Literature review

Impairment of non-current assets a special nonrecurring charge taken to write down an asset with an overstated book value. Generally an asset is considered to be value-impaired when its book value exceeds the future net cash flows expected to be received from its use.

Providing some guidance, LKAS 36 identifies a range of factors that might be considered ‘indicators of impairment’, and to the extent that the presence of these indicators leads to actual impairment it can be argued that managers are simply complying with the regulation. A significant decline in market values is also likely to be symptomatic of a decline in the value of the firms’ assets.

A company can decided to do the impairment of non current assets under the five common “indicators of impairment.” They are:

  • Evidence of physical damage, such as for a building damaged by fire or flood, when the level of damage is such that restoration efforts are needed to restore service utility.
  • Enactment or approval of laws or regulations or other changes in environmental factors, such as new earthquake standards that a facility does not meet, and cannot be modified to meet.
  • Technological development or evidence of obsolescence, such as that related to a major piece of diagnostic or research equipment.
  • A change in the manner or expected duration of use of a capital asset, such as closure of a building prior to the end of its useful life.
  • Construction stoppage, such as stoppage of construction as a result of a lack of funding.

LKAS 36 prescribes the procedures that an entity applies to ensure that its assets are carried at no more than their recoverable amount, which is the higher of the amount to be recovered through use of the asset and the amount to be recovered through sale of the asset.

The price for shares goes up and down owing to a number of factors happening from individual business units (i.e. listed company) through to a complex environment of the entire economic system. Like any other commodity, in the stock market, share prices are also dependent on so many factors. So, it is hard to point out just one or two factors that affect the price of the stocks. There are still some factors that are that directly influence the share prices.-global factors, domestic Factors and local company specific factors.

The influence from within the country is generally categorised as domestic factors. Those that are impacting on the business and investment from outside the country are defined as global factors. Thus, before buying or selling shares both global and domestic factors which may be influencing the market is identified, and a good timing of buying or selling ones shares is established.

A long-lived asset becomes impaired when an individual long-lived asset's (or asset group's) carrying amount exceeds its fair value. Developers should use three steps to recognize and measure impairment losses to determine potentially impaired long-lived assets.

First, they should consider whether impairment indicators are present.

Second, they should test long-lived assets for recoverability when certain impairment indicators arise.

Third, they should recognize an asset impairment loss only after assessing if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value.

The concern in this research is with how LKAS 36 is being implemented and how managerial discretion is being exercised. Underpinning LKAS 36 and other regulations prescribing asset impairments is the objective of requiring managers to communicate information about future cash flows to financial statement users. This recognises that managers have private information about the firm’s future prospects, and prescribing the disclosure of such information in financial reports aids in reducing the information gap between managers and outside stakeholders.

An extensive literature has developed evaluating how managers implement regulations requiring the recognition of declines in asset values, which are commonly labelled write-offs, write-downs or impairments.

Critically, there remains considerable discretion in the application of the regulation, and how that discretion is exercised generally has been addressed in a significant literature tracing back to Holthausen and Leftwich (1983), Holthausen (1990) and Healy and Palepu (1993).

According to the research of Dr. Mark P. Holtzman, William M. Sinnett they mention, applying the Feltham-Ohlson model for relating accounting information to stock market values, goodwill is a financial asset that provides returns for investors.

The act of writing off goodwill indicates to investors that management believes that these financial assets have lost value and will provide lower returns in the future. Accordingly, goodwill impairments should reduce a company’s stock-market value. And more Academic research about goodwill impairments indicates that goodwill impairments are associated with overpaying for corporate acquisitions, as impairments are most likely to be recorded when acquiring companies pay too much for targets.

Impairments are associated with low market returns before the impairment, indicating that market investors anticipate goodwill impairments. Impairments are negatively associated with corporate performance after the impairment, indicating that goodwill, once written off, does not continue to produce operating income.

Disclosures that result in the release of private information are typically labelled ‘efficient’, and examples of studies considering this include Rees, Gill and Gore (1996) who provide evidence of a positive association between asset write-downs and abnormal accruals, and Cotter, Stokes and Wyatt (1998) who provide evidence of an association between asset impairments and firms economic characteristics. Furthermore, reputational imperatives may provide incentives for management to choose appropriate accounting policies that reveal private information (e.g., Desai, Hogan, and Wilkins, 2006).

However, there is also a significant literature considering opportunistic incentives for accounting policy choice. Riedl (2004) is typical and identifies a tendency for asset write-downs to result in so-called ‘big baths’. In this circumstance, impairment may not be revealing private information about expected future performance.

Accordingly, the first issue requiring address is determining the factors impacting the

decision to undertake asset impairment. While this may simply reflect regulatory

requirements, a range of other factors are known to influence accounting policy choice. These are considered generally by Field, Lys and Vincent (2001), and includes addressing information asymmetries through the release of private information about expected future firm performance.

There is other evidence in the literature that suggests that firms’ choices of accounting procedures may be motivated by an attempt to address information asymmetries, although this tends to focus on intangible assets, where the signals or accounting choices are readily observable. For example, Wyatt (2005) suggests that firms signal the strength of the technology affecting the firms operations through their decisions to recognise intangible assets. Similarly, Wright, Thomas and Wu (2010) find that firms signal the uncertainty surrounding future returns through there accounting for R&D. Furthermore, Mohd (2005) finds that firms that capitalise their software development costs suffer less information asymmetry.

According to the research of Dr. Mark P. Holtzman impairment loss will effect on share price . Accordingly, non current assets (specially good will) impairments should reduce a company’s stock-market value. And more Academic research about goodwill impairments indicates that non currents assets impairments are associated with overpaying for corporate acquisitions, as impairments are most likely to be recorded when acquiring companies pay too much for targets. Impairments are associated with low market returns before the impairment, indicating that market investors anticipate goodwill impairments.

Impairments are negatively associated with corporate performance after the impairment, indicating that non current assets, once written off, does not continue to produce operating income.

Shipan Sun School of Accounting, Shandong Economic University, Ji’nan 250014, China research advices that maintain the perfect asset impairment accounting are important to the company and proposed it finally.

According to Marcin Michalak (University of Lodz, Poland) research poor quality of disclosures on the estimation of impairmemnt losses of non current assets will impact on valuation of performance. But not tell the definite relation ship with them.

Erlend Kvaal(BI Norwegian School of Management) For all categories of fixed asset the indications of stock market anticipation of the current value reduction of assets to be written down is very weak.

  1. Hypothesis

Firms held the operating assets for long period for their business purpose. But the value of non current assets changing more dramatic. They have to adopt the changes for their relevant reliability of accounting information for external accounting information users.

For our research we have following hypothesis.

Hypothesis 1: Impairment of non current assets and stock price positively correlated.

Hypothesis 2:- Impairment of non –current assets have a significant impact on stock price

  1. Operational concept

According to relevant researches, the operational concept of the research is shown below.

Figure 1





Impairment of assets

Carrying value

Cash generating units

Value in use

Fair value

Book value

Production units from non current assets

Discounting future cash Flows(DFS)

Active market price

cost of disposal

Cost-provision of depreciation

Amount of production

Future Cash Flows

Arms length transaction


Share price

Company earnings



Net income

Net assets per share

Solvency test

Net profit/no of shares

Net profit after tax

Net assets/no of shares

Net assets<stated capital

  1. Methodology

This research will be descriptive studies . The emphasis here is on studying a situation or a problem in order to explain the relationship between variables.

The research is based on the qualitative and quantitative analyzes of consolidated statements of public companies and financial statements of public companies. We have applies purposeful selection of the sample, which encompasses 279 financial statements included in stock exchange index.

The financial statements concern financial year 2006-2011. The index is based on the price changes of the shares of the biggest and most liquid (high turnover of shares) entities listed on the CSE.

Results stemming from next stages of the research would let the author make general conclusions as to the extend and the way of compliance with the LKAS 36 of public companies and as to the quality of disclosures in the financial statements as well as their usefulness. They also will allow to carry out comparative analysis between companies operating in different sectors(industries)., as well as allow for comparing the range and quality of the disclosures made by the public companies .

In the secondary data collection evaluate the above structure in the financial statement and made analysis about our objectives. In Sri Lanka very rare of companies have recorded non-goodwill intangibles, and the related analyses have therefore a shallower base than those of tangibles and goodwill.

  1. Data collection

Data Collection is an important aspect of any type of research study. There are two types of data collection are available. Primary and Secondary. Secondary data is data that has already been collected by someone else for a different purpose to ours.

In our research we are collecting data secondarily from companies presented financial statements to the public. In addition secondary data will be collected from research studies, books, journals, newspapers and ongoing academic working papers

When we collect the data from published financial reports I can fulfill my analyse the degree of implementation of LKAS 36 requirement to the external and quality of the information generated on non current assets impairment and the reflection of public view in the share market relevantly.

We collect the financial reports from CSE and individual web sites of the companies which published to stack holders.

  1. Sampling method

The Colombo Stock Exchange (CSE) has 279 companies representing 20 business sectors as at 25th April 2012.To collect my data we have select the CSE which have all relevant data about the listed companies and share prices. In Srilanka 279 companies are listed in CSE. But nearly 5% of companies follow the impairment of assets before amendment company act 2007. After that 98% of companies disclosed the information about the impairment of assets. But the degree of implementation of LKAS 36 percentage deviate among them.

Disclosure of the rules regarding recognition of impairment of assets 98%. Measure the impairment and made provision for non current operational assets 20%.Measure the impairment of good will and other intangible assets and written off the value 40%

• goodwill was the most frequently impaired asset, with 40% of all impairments relating to goodwill

• goodwill was the largest asset in terms of value of impairment loss

• 65% of companies in the sample did not disclose a specific accounting policy note about how the impairment loss is calculated.

The period covered the companies’ most recently published financial statements, for 2006 to 2011, based on availability of annual reports from CSE and home web pages of companies.

These were obtained either by mail in hard copy format, or downloaded electronically from the Internet. Once the published financial statements were obtained, the team read the content of each report and established which companies had disclosed an impairment charge in accordance with LKAS36.

This was done by reading the profit and loss account, balance sheet, cash flow statement and accompanying notes to the financial statements. Once the process of checking the annual reports was complete, a sample of 30 companies were found to have charged an impairment loss. This sample companies from the 278 (March 12 2012)listed companies in CSE

This fulfilled the first research objective, ie to identify those companies that have reported impairment losses under LKAS 36.

A sample of companies listed on the CSE 278 market index that apply LKAS 36 and report an impairment loss in their latest set of published financial reports were selected for analysis in this piece of research.

Finally, this report gives an assessment of the impact of impairment upon the reported financial statements.This takes the form of analysis of the impairment charge in relation to certain key financial indicators, such as profitability and book value of assets.

This report gives an informed analysis of the extent and impact of LKAS 36 on those corporations that have implemented the Standard and charged an impairment loss. This will serve as an indication of whether LKAS 36 is achieving its stated objectives and how, in practice, that affects the companies concerned.

  1. Statistical tools

I estimate regression coefficients for each category of asset, for each impairment decision

variable, and for each country as well as for both countries together. I test the hypothesis of equal practice by assessing the probability of the “national” coefficients being equal.



Independent variable

Impairment of assets

Carrying value

Cash generating units

Value in use

Fair value

Dependent variables

Share price

Net profit


Net assets per share

Solvency test

  1. Key concept

Impairment Of Assets, Accounting Information, Share Price