A New Perspective on Fixed Asset Write-Offs -- When is Earnings Management Optimal
HHL Working Paper No. 117
Posted: 11 Mar 2013 Last revised: 22 Mar 2013
Date Written: March 10, 2013
We analyze under which situations it is optimal to opportunistically delay a fixed asset write-off and when transparent reporting of write-offs is optimal. We apply a simplified real options approach to find an answer to this question. Therefore, we analyze two settings, one of which does not allow for reporting discretion while the other one does. If there is no reporting discretion the expected carrying amount can be reflected by reducing the carrying amount after depreciation by the pay-off of a put option, with the carrying amount as the strike price and the recoverable amount as the underlying. If reporting discretion exists regarding the reporting of write-offs, the payoff the firm earns when the write-off is delayed can be interpreted as the value of a barrier option with the carrying amount as the barrier and the recoverable amount as the underlying. We find that the probability that write-offs are delayed increases with the benefits of earnings management and decreases with the costs of earnings management and the benefits of transparent reporting.
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