When accruals exchange their predicting role: the case of write-ups and write-downs

Mura Alessandro, Piras Fabrizio, Valentinčič Aljoša

This study investigates whether upward (write-ups) and downward revaluations (write-offs) of non-financial fixed assets predict future performance of private firms. We show that upward asset revaluations are related to future operating performance depending on the changing net tax benefits they bring to firms. When tax benefits in the form of future tax shields are expected to exceed current tax costs in the form of “substitute tax” payable at the time of revaluation, firms revalue assets upward if they forecast positive future taxable income to exploit the net tax benefit. This results in a positive relation between revaluations and future cash flows. The financial reporting process appears as if it is consistent with reporting true firm performance. When current tax costs are low or zero, firms exploit the discretion in revaluations more loosely to achieve also other objectives of financial reporting. This results in a negative relation between upward revaluations and future cash flows. Writeoffs are never significantly negatively related to future operating performance. Indeed, they become significantly positively related to future performance during the general economic downturn. Though these findings contrast the expected outcome according to accounting standards, they are consistent with the high alignment/tax rate and the non-tax cost and benefits that characterise the setting in which private firms typically operate.

Key-Words: Earning Management, private firms, upward asset revaluations, write-offs, earnings quality