The Impact of Assets Impairment on Earnings

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The Impact of Assets Impairment on Earnings: A Special Reference to Listed Manufacturing Companies of Colombo Stock Exchange (CSE) in Sri Lanka.

Abstract. The impact of assets impairment on earnings has been a topic of international research since decades because of sever global economic crises. In this paper we derive and test the impact of assets impairment on earnings of manufacturing companies in Sri Lanka which are listed on Colombo Stock Exchange (CSE) in Sri Lanka. The application of LKAS36 measures the impairment of assets and accordingly it is necessary to disclose the information in the financial statements. The Impairment Loss (IL ) is used as independent variable while Operating Profit Ratio (OPR), Net Profit Margin (NPM), Earning per Share (EPS), Return on Asset (ROA) and Return on Equity (ROE) which are the dependent variables. The analysis are performed using data derived from the financial statements of sixteen manufacturing companies listed on CSE during the period from 2007/2008 to 2011/2012. It is found that there is a significant negative relationship between impairment loss and OPR, NPM and ROA. Further regression results also confirmed that impairment loss is significantly impact on OPR, NPM as well as ROA of listed manufacturing companies on CSE in Sri Lanka. Hence the objective of this study is to provide insights that how far firms’ earnings are impacted by entering the impairment loss in financial statements.

Keywords: Impairment of Assets, Net Profit Margin, Return on Assets

The Impact of Assets Impairment on Earnings: A Special Reference to Listed Manufacturing Companies of Colombo Stock Exchange (CSE) in Sri Lanka.

  1. Introduction

During the Global Financial Crisis (GFC) in 1990, a significant number of firms had been challenged by exceptional market instability, significant declines in profitability, continued falls in stock prices, and high level uncertainty of financial and non financial assets value. In this situation Samir Vanza and Peter Wells Anna Wright (2011) suggested that firms’ were required to recognise the impairments of assets. Organization will record impairment of assets if they detect a drop in the value of the firm’s assets below their carrying value and may or may not report an economic impairment if there are clear or unclear reporting incentives. Consequently, the recognition of assets impairment is conceptually a function of economic factors and reporting incentives (Riedl 2004). As per the economic factors viewpoint, Francis , Jennifer, Douglas and Linda (1996) argue that managers take write-offs not to manipulate earnings but to reflect declining in the values of assets due to poor firm performance, actions taken by competitors and changes in the economic climate, or changes in management strategies.

Prepared and presenting financial reports include the information of assets that is relevant for financial statement users to project the amount, timing, and uncertainty of future cash flows of assets. To do this requirement many assets are measured in various manner. Reliability and relevance are the two key qualitative characteristics of financial statements for useful decisions. Currently several accounting standard setters want to move towards the relevance of fair value than reliability of historical value even accounting information has to keep them in balance. The greatest proportion of value in financial statements is represented by non-current assets. If the companies keep the impairment process habitually, they can confirm the security and survives of them. Because of that the importance of assets impairment has been increased and the impact of assets impairment on earnings has been a topic of international research.

The impairment of assets accounting method has been introduced all over the world since the mid-1990s. However, until Sri Lankan Accounting Standard (SLAS) 42 (Lankan Accounting Standard (LKAS) 36 – 01/01/2012) was issued in 1998 there had been no rules executed as to how this should be done in Sri Lanka. Both the company law development and the development of accounting standards show an early attentiveness in Sri Lanka to the concept of impairment write-downs.

Recently, accounting for impairment of assets has received significant recognition in the popular press, due to the Global economic crisis and the ongoing steps towards convergence with LKAS36 and thereby a focus on potential balance sheet impairment has come to the forefront.

This impairment of assets policy has no suspicion had many effects on companies with some having to announce large impairment losses which have affected their reported profits or losses and other financial indicators. In this way the present study has been initiated to find out the impact between impairment loss of assets and revenue of listed manufacturing companies in Sri Lanka.

  1. Objectives

The following are the objectives of the study

  • To identify the relationship of impairment of asset and earnings of listed manufacturing companies on Colombo Stock Exchange in Sri Lanka.
  • To analyse the impact of impairment of asset on earnings of listed manufacturing companies on Colombo Stock Exchange in Sri Lanka.

1.2 Hypotheses of the Study

The following hypotheses are formulated by the researchers for the purpose of study

H1: Impairment of asset is significantly correlated with operating profit ratio of listed manufacturing companies on CSE in Sri Lanka.

H2: Impairment of asset is significantly correlated with net profit margin of listed manufacturing companies on CSE in Sri Lanka.

H3: Impairment of asset is significantly correlated with earning per share of listed manufacturing companies on CSE in Sri Lanka.

H4: Impairment of asset is significantly correlated with return on equity of listed manufacturing companies on CSE in Sri Lanka.

H5: Impairment of asset is significantly correlated with return on asset of listed manufacturing companies on CSE in Sri Lanka.

H6: Impairment of asset is significantly impact on operating profit ratio of listed manufacturing companies on CSE in Sri Lanka.

H7: Impairment of asset is significantly impact on net profit margin of listed manufacturing companies on CSE in Sri Lanka.

H8: Impairment of asset is significantly impact on earnings per share of listed manufacturing companies on CSE in Sri Lanka.

H9: Impairment of asset is significantly impact on return on equity of listed manufacturing companies on CSE in Sri Lanka.

H10: Impairment of asset is significantly impact on return on asset of listed manufacturing companies on CSE in Sri Lanka.

Research Methodology

1.3 Research Design

The current study is aimed to examine the impact of assets impairment on earnings of listed manufacturing companies of CSE in Sri Lanka. This is emphasized on studying a circumstances or a problem in order to describe the association between variables. The quantitative method has been followed in order to find better results and outcomes.

1.4 Sampling Techniques

Two hundred and ninety companies are listed under twenty sectors on CSE in Sri Lanka. The study has measured listed manufacturing companies only which out of twenty business sectors, was selected to examine their level of disclosure about impairment of assets information in the annual reports. Out of thirty seven manufacturing companies, sixteen companies has done the impairment of assets and disclosed the amount in the financial statement among the research period from 2007/2008 to 2011/2012.The study used stratified sampling to select the manufacturing sector and thereafter analyzed all the elements in the population.

1.5 Data Sources

The research is based on secondary data which has been collected from the sample companies’ annual reports. And also the websites of sampled companies’, different articles and papers are used to collect some data and information.

1.6 Reliability and Validity

Secondary data for the study were drawn from audited accounts (i.e., income statements and balance sheets) of the analysed companies as fairly accurate and reliable. As a result, these data may be considered reliable for the study. Needed checking and cross checking were done while scanning information and data from the secondary sources. All these efforts were made in order to produce validity data for the present study. Hence, researchers satisfied content validity.

Table 1: Variables and Measures

Concept

Variables

Indicators

Measurement

Impairment of assets

Impairment Loss

Financial Statements

Rupees

Profitability

Profitability

OPR

Earnings before interest and tax/ Sales

NPM

Net Profit / Sales

EPS

Net profit/no of shares

ROE

Net Profit/shareholders fund

ROA

Net Profit/non-current assets

1.7 Mode of Data Analysis

In the present study the collected data is analyzed by descriptive statistics (i.e., means, maximum, minimum and standard deviation) and inferential statistics (i.e. person’s correlation, paired sample test and simple regression). The results were obtained by applied the SPSS 20.The following models were created by the researchers for the purpose of study.

OPRt= b0 +b1 x IL+Et– model 1

NPMt= b0 +b2 x IL+Et– model 2

EPSt= b0+b3 x IL+Et– model 3

ROAt = b0 +b4 x IL+Et– model 4

ROEt= b0+b5 x IL+Et– model 5

Where b0 denotes the intercept of the regression equation, and b1, b2, b3, b4, and b5 are the regression coefficients of impairment amount on profitability. IL means Impairment Loss

2 Results

2.1 Correlation Analysis

Table 2: Summary of the Correlation Analysis

OPR

NPM

EPS

ROE

ROA

Impairment Loss

Pearson Correlation

-.680**

-.836**

.028

-.275

-.485**

Sig. (2-tailed)

.000

.000

.873

.105

.003

N

36

36

36

36

36

**. Correlation is significant at the 0.01 level (2-tailed).

The results show that impairment loss has negative association with operating profit ratio, net profit margin and return on asset. Pearson correlation for impairment loss with operating profit ratio, net profit margin and return on asset are -0.680, -0.836and -0.485. This means there is a negative relationship between impairment loss and earnings of listed manufacturing companies on CSE in Sri Lanka and there was a significant relationship between these variables at 1% level. This indicates that impairment loss increases but the earnings will be decreased negatively or in other words, when the impairment loss decrease, the earnings will be increased.

Table3: Hypotheses Testing of Correlation Results

Hypotheses

Accepted/ Rejected

H1

Impairment of asset is significantly correlated with operating profit ratio of listed manufacturing companies on CSE in Sri Lanka

Accepted

H2

Impairment of asset is significantly correlated with net profit margin of listed manufacturing companies on CSE in Sri Lanka

Accepted

H3

Impairment of asset is significantly correlated with earning per share of listed manufacturing companies on CSE in Sri Lanka

Rejected

H4

Impairment of asset is significantly correlated with return on equity of listed manufacturing companies on CSE in Sri Lanka.

Rejected

H5

Impairment of asset is significantly correlated with return on asset of listed manufacturing companies on CSE in Sri Lanka

Accepted

2.2 Regression analysis

Table 4: Summary of the Regression Analysis

Model

R

R Square

Adjusted R Square

Std. Error of the Estimate

Sig. of anova table

OPR

.612a

.375

.356

.35748

.000

NPM

.836a

.699

.690

.32556

.000

EPS

.028a

.001

-.029

6.69178

.873

ROA

.485a

.235

.213

.08491

.003

ROE

.275a

.076

.048

.31121

.105

a. Predictors: (Constant), Impairment Loss

The table No. 4 shows the model summary of regression analysis. The results revealed that the impact of independent variable on dependent variable. According to the analysis, the value of adjusted R square is 0.356. It means that there is 35.6 % impact of independent variable of impairment of loss on the dependent variable of operating profit ratio of listed manufacturing companies. Further table indicates that the independent variable of impairment of loss significantly impact on net profit margin too. According to the Adjusted R square is 0.690, it is clearly pointed out that there is 69% percentage of net profit margin which can be explained by the impairment of asset. It can be statistically concluded that the model does not fit to examine the impairment loss with earnings per share and return on equity. The adjusted R square for impairment loss with return on asset is 0.213. This means 21.3% variance in ROA is accounted by the impairment loss and other 78.7% variance in the ROA is attributed to some other factors of listed manufacturing companies in Sri Lanka.

Table 5: Coefficients of regression analysis

Model

Unstandardized

Coefficients

Standardized Coefficients

t

Sig.

Dependent Variable

B

Std. Error

Beta

(Constant)

.171

.063

2.734

.010

OPR

Impairment Loss

-2.982

.660

-.612

-4.514

.000

(Constant)

.147

.057

2.585

.014

NPM

Impairment Loss

-5.332

.600

-.836

-8.887

000

(Constant)

2.920

1.174

2.487

.018

EPS

Impairment Loss

.200

1.240

.028

.161

.873

(Constant)

.060

.015

3.984

.000

ROA

Impairment Loss

-2.071

.641

-.485

-3.232

.003

(Constant)

.071

.056

1.267

.214

ROE

Impairment Loss

-2.640

1.583

-.275

-1.668

.105

From this table no. 5, we can formulate the following models.

OPRt= 0.171 + (-2.982) x IL+Et– model 1

NPMt= 0.147 + (-5.332) x IL+Et– model 2

EPSt= 2.920 + (0.200) x IL+Et– model 3

ROAt= 0.060 + (-2.071) x IL+Et– model 4

ROEt= 0.071 + (-2.640) x IL+Et– model 5

Table 6: Hypotheses Testing of Regression Analysis

Hypotheses

Accepted/ Rejected

H1

Impairment of asset is significantly impact on operating profit ratio of listed manufacturing companies on CSE in Sri Lanka

Accepted

H2

Impairment of asset is significantly impact on net profit margin of listed manufacturing companies on CSE in Sri Lanka

Accepted

H3

Impairment of asset is significantly impact on earnings per share of listed manufacturing companies on CSE in Sri Lanka

Rejected

H4

Impairment of asset is significantly impact on return on equity of listed manufacturing companies on CSE in Sri Lanka.

Rejected

H5

Impairment of asset is significantly impact on return on asset of listed manufacturing companies on CSE in Sri Lanka

Accepted

Table 7: Paired Samples Test

Paired Differences

t

df

Sig. (2-tailed)

Mean

Std. Deviation

Std. Error Mean

95% Confidence Interval of the Difference

Lower

Upper

Pair1

OPRBI - OPR

.0296

.0926

.0156

-.0021

.0614

1.893

34

.067

Pair2

NPMBI - NPM

.0300

.0921

.0153

-.0011

.0612

1.957

35

.058

Pair3

EPSBI - EPS

.2958

.9121

.1520

-.0127

.6044

1.946

35

.060

Pair4

ROABI - ROA

.0086

.0211

.0035

.0014

.0157

2.436

35

.020

Pair 5

ROEBI - ROE

.0149

.0332

.0055

.0037

.0262

2.704

35

.011

The paired sample t-test was carried out to identify the significant difference between before and after the impairment loss. As it is at a = 0.05 level of significance, it has enough evidence to conclude that there is a difference in the mean indexes for the two areas. There is a significant difference on Return On Asset and Return On Equity before and after impairment of assets. At the same time there is no difference on other factors.

3. Conclusion

The current study has investigated the impact of impairment loss on earnings of manufacturing companies which are listed in Sri Lanka. The samples data were collected from sixteen listed manufacturing companies in Sri Lanka. Considerable evidences were found for hypotheses. This findings suggest that various relationships between impairment of loss and earnings exist.

The study confirmed there is a strong negative relationship between impairment losses and Operating Profit Ratio, Net Profit Margin and Return On Asset. Further this study indicates that impairment loss significantly impact on Operating Profit Ratio, Net Profit Margin and Return On Asset. The outcomes of the study may guide the companies to get the awareness regarding the LKAS 36 and the financial reports of future companies could be improved by the measurement and disclosure of impairment of assets. The companies should be built-in a clear cause of impairment stated clearly in the annual reports with associate values.

References

  1. Changlin, Z., Stephen, H., Elaine, E.: The Global Financial Crisis and Fair Value Accounting: How US Non- Financial Companies Played the Measurement Game. Macquarie University. (2012)
  2. Ching, L.C., Chu , Y.C, Chen, W.L.: Impairment components of Earnings in Taiwan: Empirical Findings Under Manipulation/Non Manipulation Regimes. AAA. USA. 11, 474—483. (2011)
  3. Francis, Jennifer, Douglas, J., Linda, V.: Causes and Effects of discretionary Asset Write-offs. Journal of Accounting Research. 34(3).117-134.(1996)
  4. Greg, T., Zhu, X. Y.: Asset Impairment disclosure in China. School of Accounting, Curtin University of Technology. (2006)
  5. Riedl, E.J.: An Examination of Long-Lived Assets Impairment. The accounting Review. 79(3), pp. 823--852. (2004)
  6. Sri Lanka Accounting standard – LKAS 36. Impairment of Assets. (2012)
  7. Sooriyakumaran, L., Velnampy, T.: Disclosures and impacts of impairment of non-current assets in the financial statements: A study on listed manufacturing companies in Colombo Stock Exchange(CSE) in Sri Lanka, Merit Research Journal of Accounting, Auditing, Economics and Finance Vol. 1(6) pp. 122-133. (2013)
  8. Zhao, C.: Asset Impairments and Earnings Management: Policy Implications of Asset Impairment Principle. Accounting Research. (2006).

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