Hi Guys,
I am reading one of this sentence - Restructuring provisions and impairment losses provide opportunities to time the recognition of losses (i.e., earnings management). Typically, recognition of impairment or restructuring losses in a period reflects overstatement of income in prior periods.
My questions is that why recognition of impairment or restructuring losses in a period would reflect overstatement of income in prior periods.
Hi Guys, I have found the answers myself. Normally, the impairment had actually occurred over a longer period than that single year, which would result into the overstatement of prior periods.
Thanks
Matching principle dictates that revenues need to be matched with respective expenses. IFRS and US GAAP are also accrual based accounting frameworks, so basically both revenue and expenses need to be recognized in the periods they were incurred, even if cash is not collected/paid then. Like you realised, an impairment loss (say of receivables) recognised in a period, likely points to revenue recognised in a previous period that shouldn’t have been recognised (as it turns out collection is not probable, which is one of the criteria for recognition), hence the overstatement. Also, it is entirely possible that this impairment loss may not have been booked in the actual period it occurred, as it is largely a matter of professional judgment of management/accountants to identify and quantify such losses. More aggressive accounting treatment by management due to pressure for results might cause them to “massage” the figures and delay those losses (this affects the net profit, but not income, as in your original question though).
Thank you for your kindly reply.
So if there is an impairment that has been long impending and a company chooses to show it in the current period, YES !!! previous year statements would be overstated.
Think of it this way: if the asset is impaired (i.e., its value is less than the book value shown), that suggests that you haven’t been depreciating it fast enough. So your previous years’ depreciation expenses should have been higher.
Understated expenses means overstated (net) income.
Thanks for you kindly answer!
My pleasure.