Hesitation in recognising impairment losses

Shipping companies are reluctant to recognise impairment losses, as they are seen as a negative signal by the market and may create unwanted volatility in financial statements.
This is one of the conclusions that Anna Karin Pettersson at the School of Business, Economics and Law at the University of Gothenburg, draws in her PhD-thesis “Impairment of Ships- A study of how IAS 36 has been applied in European shipping companies”.

The IAS 36, the Impairment of Assets- standard, a part of the International Financial Reporting Standards, relies on management judgment and the use of private information.

To assess what makes European shipping companies recognise impairment losses, Pettersson has investigated annual reports from all listed European shipping companies for the years 2007 through 2010. She also made in-depth interviews with representatives from ten shipping companies from six different countries.
The way different companies choose to recognise impairment losses varies. The companies have to consider how the market will react on their impairment. Pettersson’s study shows that companies generally hesitate to recognise impairment losses.
Therefore, it can be assumed that impairment losses are delayed in relation to the economic substance and that accounting will lag the economic impairment. There is also the risk that impairment charges will be excessive when they are finally recognised with the aim of avoiding recurring charges. There is a reluctance to reverse impairment losses from previous years for the same reason. 

The study shows that companies that are exposed to operational risks and volatility and that have ships that are easy to value recognise excess depreciation charges in order to avoid impairment losses.
There is basically a greater reluctance if the impairment is believed to surprise the market, but it may also be the other way. Companies may take advantage of the market’s expectations by recognising impairment losses, and thereby create better prospects for the future.
Finally, an impairment loss may be recognized because a ship is to be scrapped or sold. In the latter case, the impairment loss relates to a different economic situation, is based on actual decisions and events, and is of a permanent characteristic.
The thesis also deals with the amount of information about impairment losses companies provide in annual report disclosures.
Pettersson found that the information provided in the reports is mainly adapted for national readers. The more shipping companies on the national stock market, the more information will mostly be found in the reports. Also the national praxis has influence in the amount of information. The companies’ economic situation, though, doesn’t seem to affect the information content.
Pettersson concludes that principle-based accounting works in the shipping industry, at least in some sense.  There also exists a number of issues, such as shipping companies exposed to operational risks and volatility prefer conservative accounting, and that it can be hard for users to understand how impairment tests are conducted based on the information disclosed in annual reports.

Anna-Karin Pettersson successfully defended her thesis Friday March 6.