Does Fair Value Accounting for Non-Financial Assets

Pass the Market Test?

Hans B. Christensen and Valeri V. Nikolaev

The University of Chicago

Booth School of Business
5807 South Woodlawn Avenue
Chicago, IL 60637

Abstract: The choice between fair value and historical cost accounting is the subject of long-
standing controversy among accounting academics and regulators. Nevertheless, the market-
based evidence on this subject is very limited. We study the choice of fair value versus historical
cost accounting for non-financial assets in a setting where market forces rather than regulators
determine the outcome. In general, we find a very limited use of fair value accounting. However,
the observed variation is consistent with market forces determining the choice. Fair value
accounting is used when reliable fair value estimates are available at a low cost and when they
convey information about operating performance. For example, with very few exceptions, firms’
managers commit to historical cost accounting for plant and equipment. Our findings contribute
to the policy debate by documenting the market solution to one of the central questions in the
accounting literature. Our findings indicate that despite its conceptual merits, fair value is
unlikely to become the primary valuation method for illiquid non-financial assets on a voluntary
basis.

Keywords: Fair value, IFRS, non-financial assets, illiquid assets.

JEL Classification: M4, M41

This version: 4 November 2012


This paper previously circulated under the title: "Who uses fair-value accounting for non-financial assets after
IFRS adoption?" This research was funded in part by the Initiative on Global Markets at the University of Chicago
Booth School of Business. We benefited from helpful comments from two anonymous referees, Ray Ball, Philip
Berger, Jannis Bischof, Alexander Bleck, Christof Beuselinck, Johan van Helleman, S.P. Kothari, Laurence van
Lent, Christian Leuz, Paul Madsen, Karl Muller, Edward Riedl, Douglas Skinner, Richard Sloan, Abbie Smith,
Stephen A. Zeff, Ross Watts, Li Zhang, workshop participants at the EAA 2009 Annual Meeting, University of
Chicago, University of North Carolina’s GIA Conference, Harvard University’s IMO Conference, ISCTE, and
Tilburg University. Michelle Grise, SaeHanSol Kim, Shannon Kirwin, Ilona Ori, Russell Ruch, and Onur Surgit
provided excellent research assistance.
1. Introduction

The choice between fair value and historical cost accounting is one of the most widely

debated issues in the accounting literature. While the debate dates back to the 1930s (Paton 1932,

pp. 739-747, Fabricant 1936), it is still unsettled (e.g., Schipper 2005, Ball and Shivakumar

2006, Watts 2006, Hail, Leuz and Wysocki 2010, Laux and Leuz 2009). One impediment to

moving the debate forward is the lack of evidence on the choice between the two accounting

practices, when the choice is determined by market forces rather than regulators (Kothari et al.

2010). We exploit a quasi-experiment embedded in the recent mandatory adoption of the

International Financial Reporting Standards (IFRS) to study the “market solution” for the choice

between historical cost and fair value accounting methods. Our approach follows Leftwich

(1983), who documents that private markets often differ from regulators in their accounting

method choice.

Our setting has a number of advantages. First, unlike most other accounting standards,

IFRS provides a free choice between fair value and historical cost accounting for non-financial

assets. The second and more important advantage of the current setting is that IFRS requires ex

ante commitment to one of the two accounting policies.1 It is, ex ante, in management’s interest

to limit the scope for future opportunistic actions, e.g., earnings management (Jensen and

Meckling 1976, Watts 1977, Watts and Zimmerman 1986, Ball 1989). Therefore, firms’

1
A number of prior studies have examined settings where firms were not required to commit to either fair value or
historical costs but could ex post revalue non-financial assets. Evidence from the US prior to 1940 is provided in
Fabricant (1936) and ARB (1940). Evidence from Australia is provided in Whittred and Chan (1992), Brown et al.
(1992), Easton et al. (1993), Cotter and Zimmer (1995), and Barth and Clinch (1996, 1998). Evidence from the UK
is provided in Amir et al. (1993), Barth and Clinch (1996), Aboody et al. (1999), Muller (1999), and Danbolt and
Rees (2008).

1
managers have stronger incentives to respond to market demands and commit to the accounting

treatment that maximizes the value of the firm (i.e., is more efficient).2

We study valuation practices for arguably the most controversial (non-financial) asset

groups: property, plant and equipment (PPE), investment property, and intangibles. Out of the

twenty-nine European countries that mandated IFRS from 2005, we select the United Kingdom

(UK) and Germany because they have the largest financial markets in Europe and are historically

at opposite ends of the spectrum in terms of using fair value accounting under the local GAAP.

Specifically, for non-financial assets, German GAAP allows only historical cost accounting,

whereas UK GAAP either allows (for PPE) or mandates (for investment property) fair value

accounting. As a result, IFRS expands the available valuation practices in both the UK and

Germany. Indeed, under IFRS, both fair value and historical cost are allowed for PPE and

investment property; and, if an active market exists, for intangibles.3 The free choice under IFRS

allows managers representing outside stakeholders to reveal preferences with respect to valuation

practices.

To better understand whether preferences revealed by the managers reflect market

demand and supply forces, we analyze the observed choices from an economic cost-benefit

perspective. On the demand (benefit) side, fair value accounting seems superior to historical cost

on most qualitative characteristics described in the Financial Accounting Standard Board’s

(FASB) conceptual framework (e.g., Hermann et al. 2006). The only exception is, arguably, the

reliability criterion on which historical cost is likely to score higher. Indeed, consistent with the

merits of fair value outweighing the cost of potentially lower reliability, some commentators

2
Note that distinguishing between opportunism and value maximizing explanations is central to understanding
accounting choices but rarely achieved in practice (Fields et al. 2001).
3
An active market rarely exists for intangibles and, hence, the managerial choice of valuation policies for
intangibles cannot be consider as free as for PPE and investment property.

2
have explicitly or implicitly criticized the Securities and Exchange Commission’s (SEC) de facto

ban on upward revaluations of non-financial assets in effect since 1940 (see Graham and Dodd

1951, Weston 1953, Paton and Dixon 1958, Hermann et al. 2006). Therefore, our prediction is

that the IFRS adoption is associated with a significant shift towards fair value accounting for

non-financial assets among firms that were constrained to historical cost accounting under local

GAAP.

We test a number of cross-sectional predictions focusing on the cost-benefit tradeoffs

between the two valuation practices. First, we expect that local economic, governance, and legal

institutions influence the market solution in a predictable manner. Second, as reliability is the

principal dimension on which historical cost arguably dominates fair value, the costs of

constructing reliable fair value estimates are expected to be a key cross-sectional determinant of

the choice between the two accounting practices. We predict that fair value accounting is more

likely chosen for property than other non-financial assets because property markets are generally

more liquid. Our third prediction is that managers are more likely to adopt fair value when it

facilitates performance measurement: (1) value changes in investment property are informative

of operating performance when capital gains are part of the business model, and thus we expect

the use of fair value among real estate firms that hold investment property; (2) fair value

adversely affects key performance measures (e.g., ROA) if the management chooses to hold

unproductive assets (assets with high value in alternative use) and thus can benefit in governing

firms lacking investment opportunities. Finally, we expect that reliance on debt-financing

influences the choice of fair value, although the direction of this relation is unclear ex ante: on

the one hand debtholders can demand a greater degree of verifiability, but, on the other hand,

3
they also require estimates of the value of the collateral. We elaborate on these predictions in

Section 3.

To test the above predictions, we manually collect data on valuation practices used in

Germany and the UK around the IFRS adoption. Our sample comprises the Worldscope universe

of companies domiciled in the UK and Germany for which we can obtain an annual report – in

total 1,539 companies. We identify the valuation practices by reading the accounting policy

sections of the companies’ annual reports. There is significant variation in the chosen accounting

practices for PPE, investment property, and intangibles.

Our findings are as follows: (1) For PPE, we find that only 3% of the sample firms use

fair value accounting for at least one asset class following the IFRS adoption. With very few

exceptions, these companies use fair value accounting for the property asset class only; members

of the plant and equipment asset classes are valued at historical cost in almost all cases. An even

more striking observation emerges for companies that used fair value under local GAAP: 44% of

these firms switch to historical cost accounting upon the IFRS adoption. In contrast, among

companies that previously recognized all PPE asset classes at historical cost under the local

GAAP, only 1% switches to fair value for at least one asset group; (2) For investment property

(i.e., property held for the purpose of earning rental income or for capital appreciation), we find

that companies are equally likely to use historical cost and fair value accounting; (3) For

intangible assets, we find that all firms in the sample pre-commit to historical cost, consistent

with the stricter requirements under IFRS for valuing intangibles at fair value. Overall, our

results do not support the prediction that firms’ managers find the shift towards fair value

accounting to be a beneficial commitment.

4
 However, further tests do indicate that the choice to use fair value varies meaningfully

with its economic costs and benefits. Consistent with our first prediction, we find that

institutional differences are important determinants of the choice to use fair value. Consistent

with the second prediction, managers use fair value when the costs of obtaining reliable

estimates are relatively low, i.e., for more liquid (or re-deployable) assets such as property and

investment property. Consistent with our third prediction, fair value is more common when it is

expected to facilitate performance measurement. Specifically, we find that for firms holding

investment property, the fair value choice is positively associated with real estate being a

primary activity. We also find some evidence that companies with lower investment

opportunities use fair value. Finally, consistent with our last prediction, the reliance on debt

financing is positively associated with the use of fair value for both investment property and

PPE. This finding is robust and holds both when measuring the reliance on debt by leverage and

the frequency of accessing debt markets. In sum, while our evidence suggests that market supply

(cost) and demand (benefit) factors influence the choice of fair value versus historical cost

accounting, historical cost is by far the dominant accounting practice when market forces

determine the outcome of the choice.

Our paper contributes to the policy debate over fair value accounting by documenting a

market solution for the choice between historical cost and fair value for non-financial assets.

Understanding the market solution provides input into regulators’ decision-making process.

While market solutions are often the efficient (welfare increasing) outcomes, this is not always

the case due to possible market failures. First, managements’ choice should be exercised under

the principles of free exchange and in the absence of externalities (e.g., coercion on part of

auditors or industry organizations). Second, if free markets fail to discipline management to

5
promote the interests of outside investors, e.g., due to governance failure or the presence of

information asymmetry, managers may choose accounting practices opportunistically (in their

private interest). However, if the more than 95% of firms that chose historical cost do so for

opportunistic reasons, the governance failure should take a rather extreme form. Furthermore,

two additional features of our setting render opportunism to be unlikely: (1) the IFRS

requirement to pre-commit to either fair value or historical cost, and (2) the absence of

information asymmetry between the principal (investors) and the agent (management) with

respect to the agents’ actions (choice of accounting practice). For these reasons, management is

likely to ultimately bear the cost of its opportunistic choices and to be subject to market

discipline in our setting. Nevertheless, regulators need to consider potential market failures and

their effect on the reporting choices.

We also contribute to the debate over fair value by adding to the studies that document

the benefits of fair value accounting for non-financial assets such as increased value relevance

and information content (Sharpe and Walker 1975; Standish and Ung 1982, Easton et al. 1993;

Barth and Clinch 1996, 1998; Aboody et al. 1999; Danbolt and Rees 2008), reduced information

asymmetry (Muller et al. 2011), and increased comparability (Cairns et al. 2011). Our findings

suggest that the choice to use fair value is not random and occurs when benefits outweigh the

costs. Yet, our evidence suggests that the vast majority of managers find the net benefits from

fair value accounting to be rather limited. Indeed, our evidence is consistent with opportunistic

revaluations of non-financial assets documented in settings where fair value accounting is

6
mandatory (e.g., Ramanna and Watts 2012) and the acclaimed opportunism in revaluations in the

1920s, which initially motivated the SEC to ban upward revaluations in 1940 (Zeff 1995, 2007).4

Section 2 describes the accounting traditions in the UK and Germany, as well as the

valuation methods available to companies under German GAAP, UK GAAP, and IFRS; Section

3 develops testable hypotheses; Section 4 describes the sample selection procedure and presents

our results; and Section 5 concludes.

2. Distinctions of the IFRS-based setting and the institutional details

2.1 Fair value under IFRS vs. settings in prior literature

The current setting that exploits the IFRS adoption has a valuable distinction from the

Australian, UK, and US settings used in prior research. The choice between historical cost and

fair value must be stated in the accounting policy section of the annual report following the IFRS

adoption and must be applied consistently going forward (analogous to, e.g., revenue recognition

or inventory valuation methods).5 A company that chooses to use fair value must revalue assets

every time the book value is materially different from the market value (IAS 16 and IAS 40). A

company that chooses historical cost cannot perform upward revaluations in the future. A switch

between historical cost and fair value is considered a voluntary change in accounting principles

and needs to be justified to auditors, lenders, equity investors, and potentially to regulators.

Therefore, the choice between fair value and historical cost in our setting effectively represents

an ex ante commitment, and as such is unlikely to be driven by earnings management

considerations. Indeed, the early studies argued that discretionary revaluations are related to

4
Agents have incentives to pre-commit against ex post opportunism if a pre-commitment mechanism exists –
otherwise the agent will bear the costs (Jensen and Meckling 1976). Under IFRS, historical cost is a pre-
commitment mechanism against future revaluations.
5
Note that both the UK and Australia adopted accounting standards in 1999 and 2000 that are similar to IAS 16,
however, the prior literature we refer to rely on data before this change.

7
contracting motives – consistent with the finding that leveraged companies in danger of violating

covenants are more likely to revalue assets (Brown et al. 1992; Whittred and Chan 1992; Cotter

and Zimmer 1995).6

The problem with discretionary revaluations is that managers decide whether to revalue

assets ex post after they know the effect of the fair value estimate on the financial statements. For

instance, managers may only revalue assets when they need to manipulate reported performance.

Alternatively, managers may revalue assets when reliable fair value estimates are available. Our

setting isolates this issue as we examine ex ante choices to use fair value with limited ex post

discretion to change the valuation method. Ex ante, the pre-commitment to contracting

(accounting) practices that minimize agency costs is efficient (Jensen and Meckling 1976, Watts

and Zimmerman 1986). Thus, pre-commitments to fair value are more likely to be informative

about firm-specific net benefits, rather than managerial opportunism, as compared to ex post

revaluations.

2.2 Accounting in the UK and Germany

Despite the EU’s accounting harmonization that began decades prior to the mandatory

IFRS adoption, the UK and Germany arguably have the two most distinct asset valuation

traditions in Europe at the time of IFRS adoption. The differences in their accounting traditions

are due to institutional differences in economic, governance, and legal systems. Germany was

traditionally characterized by the existence of private companies who raised capital from banks

and communicated via private information channels (Leuz and Wüstemann 2004). Accounting

was mainly used to establish taxable income; hence, accounting regulation was codified and

6
Whittred and Chan argue that asset revaluations reduce underinvestment problems that arise from contractual
restrictions, while Cotter and Zimmer argue that upward revaluations increase borrowing capacity. While debt
contracting is the main explanation for asset revaluations, Brown et al. also find that bonus contracts, as well as
signaling and political cost explanations, play an important role.

8
focused mainly on legal entity statements. As revaluations are often in conflict with the

objectives of tax authorities, German GAAP only allowed historical cost accounting. Today in

Germany, there is no formal link between legal entity reports, which are still used primarily for

tax purposes, and consolidated financial statements. Thus, financial reporting choices in the

consolidated statements, including the valuations of non-financial assets, have no tax

consequences.

In contrast, the UK’s accounting practices have historically developed separately from

tax accounting and in the private sector rather than in company law. UK ownership is dispersed,

and even middle-sized companies are commonly listed on the London Stock Exchange. Such an

ownership structure requires that financial reporting reduces information asymmetry, and in this

context revaluations can serve the purpose of conveying information about the assets’ current

values.

Figure 1 summarizes the permitted accounting treatments for non-financial assets—

investment property, PPE, and intangible assets—under UK GAAP, German GAAP, and IFRS.

In brief, German GAAP prescribes historical costs for all three asset groups, whereas UK GAAP

allows a choice between fair value and historical costs for PPE and intangibles but requires fair

value for investment property. In contrast, IFRS allows a choice between fair value and historical

costs for all three asset groups, although an active market is a requirement for using fair value for

intangibles. See Appendix A for a detailed explanation of the accounting treatments under each

accounting regime.

3. Empirical predictions

The choice between fair value and historical cost accounting of accounting standard

setters such as the FASB and the International Accounting Standards Board (IASB) is guided by

9
their conceptual frameworks that emphasize and promote the decision-usefulness of accounting

information. The decision-usefulness perspective faces a central trade-off between the relevance

and the reliability of accounting information.7 In recent years, both FASB and IASB have

emphasized relevance as more important than reliability that manifests itself in a shift towards

fair value accounting.8 This change in focus is reflected, for example, in the conclusion of a

discussion of relevance and reliability by L. Todd Johnson, a senior project manager at FASB:

The Board has required greater use of fair value measurements in financial statements
because it perceives that information as more relevant to investors and creditors than
historical cost information. Such measures better reflect the present financial state of
reporting entities and better facilitate assessing their past performance and future
prospects. In that regard, the Board does not accept the view that reliability should
outweigh relevance for financial statement measures (Johnson 2005).

Fair value measurement is justified on the grounds of being more relevant for the

decisions by users of financial statements. For example, revaluations to fair value allow

managers to convey their private information on asset values (Aboody et al. 1999). Fair value is

also argued to improve transparency, comparability, and the timeliness of accounting

information (Schipper 2005). In line with the benefits of fair value accounting, many studies on

asset revaluations find that fair value possesses superior relevance. These studies find that

upward revaluations have a positive association with equity returns in the month of the

revaluation (Sharpe and Walker 1975; Standish and Ung 1982), and that they have association

with long-window stock returns, future cash flows, and the market value of equity (e.g., Amir et

al. 1993; Easton et al. 1993; Barth and Clinch 1996, 1998; Aboody et al. 1999; Danbolt and Rees

7
See IASB's Framework paragraph 45 and FASB's Conceptual Statement 2 paragraph 15.
8
See for example IASB Discussion Paper July 2006, paragraph BC2.62.

10
2008). In contrast, historical cost is likely to conceptually dominate fair value on the reliability

dimension (Herrmann, et al. 2006).9

However, an important question that remains unanswered is whether, in a free market for

accounting principles, managers choose fair value over historical cost. Managers, who represent

outside stakeholders, have economic incentives to respond to market demands and to select a set

of accounting principles that reflect the interests of the firms’ stakeholders. Thus, the observed

choice outcomes represent the market solution to fair value vs. historical cost accounting. IFRS

offers an opportunity to examine whether the observed choice by firms’ management is

consistent with IASB’s (and FASB’s) shift towards fair value accounting in accounting

standards. In such a case, one should expect that the IFRS adoption is associated with a shift

towards fair value accounting for non-financial assets.

3.1 Cross-sectional predictions.

Next, we examine whether management’s decision to use fair value is explained by

market supply and demand factors related to the costs and benefits of fair value accounting. In a

market, fair value is expected to be used when the economic benefits net of its costs compare

favorably to those of historical cost accounting.

First, as discussed earlier, there are important distinctions in economic and legal

institutions across the UK and Germany. While we cannot exploit variation in the institutional

factors because we only have two countries, we do expect that the market solution will exhibit

important differences across the two countries (Ball 2006). In particular, based on the discussion

9
Barth et al. (2001) argue that the value relevance tests are joint tests of relevance and reliability, because a certain
degree of reliability is also established by rejecting the null of no association. Although value relevance tests
establish a minimum level of reliability of observed revaluations, the level is presumably below the reliability of
historical cost where the accounting treatment generally leaves little discretion to management.

11
in subsection 2.2 we expect that the German economic institutions are less suitable to fair value

accounting than the UK economic institutions:

H1: Fair value is more likely to be used in the UK than Germany following the IFRS adoption.

Second, the effort and resources a company needs to expend in order to obtain reliable

fair value estimates are likely to play an important role in determining a manager’s choice of

valuation practice. The ability to obtain reliable fair value estimates is closely related to the

existence of liquid markets for assets that provide an independent source of verification (Watts

2006). Because property is typically more re-deployable than other non-financial assets and has

relatively liquid markets (Shleifer and Vishny 1992) we predict that fair value is more frequently

used as a valuation practice for property relative to other non-financial assets:

H2: Managers are more likely to choose fair value accounting for property than plant,

equipment, and intangible assets.

On the benefit side, we expect fair value accounting to be used when it is more likely to

facilitate performance measurement and hence to be useful in evaluating a firm’s management.

First, changes in the value of investment property are likely informative about the operating

performance of firms that primarily invest in real estate, because realizing capital gains are often

part of their business model. Second, fair value can discipline investment activity among

companies with relatively few investment opportunities. Such firms can be prone to

overinvestment (or the failure to discontinue bad projects) because the historical cost does not

reflect the investments’ opportunity costs, e.g., a company’s headquarters purchased many years

ago may be fully depreciated. In contrast, fair value forces managers to incur rent on their

investments’ current values, regardless of the time of purchase and their historical cost. More

generally, common accounting metrics—for example, return on assets or return on investment—

12
are more likely to reflect economic performance under fair value because the depreciated cost

(which is usually lower than market value) does not account for the value in alternative use (see

Appendix D). In other words, fair value accounting dilutes the return on assets, makes it more

costly for management to hold unproductive assets, and can improve performance measurement

(subject to reliability concerns). Given the above arguments, our third prediction is:

H3: Fair value is more likely to be used when recognizing asset-value changes in a timely

manner facilitates performance measurement.

Finally, we explore whether reliance on debt financing influences the use of fair value

accounting. On the one hand, debtholders have a demand for reliable information as it limits the

extent of managerial discretion in accounting measurement (e.g., Watts 2003). To this end, they

are likely to favor contracts written in terms of historical-cost-based measures. At the same time,

most contracts exclude the revaluation reserve and hence contracting, in the case of PPE, is not

directly influenced by fair value accounting (Citron 1992). On the other hand, companies that

access debt markets are commonly required, under their credit arrangements, to provide

valuations of collateral. The fact that lenders are willing to lend against these valuations implies

that a company invests in measuring them reliably (e.g., independent valuation and

certification).10 Therefore, recognizing the fair values of these assets in general purpose financial

statements is associated with low incremental costs (Holthausen and Watts 2001). Thus, our

fourth hypothesis is:

H4: Fair value accounting has a positive association with reliance on debt financing.

10
Muller and Riedl (2002) document that fair value estimates produced by independent valuators are viewed by
capital markets as being more reliable than fair value estimates produced by managers.

13
4. Results

4.1 Sample selection

We manually verify the accounting standards that a given company follows in either the

accounting policy section or the auditor’s opinion section of its annual report(s). To identify the

asset valuation practice a company follows, we read the accounting policy section of its annual

report(s). We begin with all of the UK and German companies (active and inactive) in

Worldscope and further restrict the sample to the companies that comply with IFRS in either

2005 or 2006. For inclusion in the German and UK cross-sectional samples, we further require

that a company has an annual report under IFRS in Thomson One Banker. We construct a cross-

sectional sample to examine the valuation practices after the mandatory IFRS adoption and a

switch sample (UK only) to examine whether companies use the IFRS adoption to switch their

accounting practices. For inclusion in the UK switch sample, we also require that a company has

an annual report (prepared according to UK GAAP) before the IFRS adoption.11

Table 1, Panels A and B present the distribution by industry of the companies in

Worldscope as well as in the German sample, the UK cross-sectional sample, and the UK switch

sample. The industry distribution in each sub-sample approximates that of Worldscope.

4.2 Valuation practices

In this section, we provide evidence on the prevalence of valuation practices in the UK

and Germany. A company is classified as applying fair value accounting if it recognizes at least

one asset class (within an asset group) at fair value. Similarly, a company is classified as

applying historical cost if it recognizes at least one asset class (within an asset group) at

11
For companies both in Germany and the UK, we obtain their first annual report under mandatory IFRS, which is
typically for fiscal year 2005. In addition, for companies in the UK, we look for their last UK-GAAP annual report,
which is typically for fiscal year 2004. In the rare cases where we cannot find these annual reports, we take the next
annual report available in Thomson One Banker (e.g., for fiscal year 2006).

14
historical cost. Appendix B presents examples of fair value accounting and historical cost

accounting for PPE.

4.2.1 Valuation practices in the UK

Table 2 documents the valuation practices in the UK cross-sectional sample. We identify

a complete absence in the use of fair value accounting for intangible assets; instead, all

companies in our sample rely on historical cost for this asset group. For PPE, 5% of companies

use fair value accounting while all companies use historical cost for at least one asset class

within this asset group. We observe that the fair value use differs across industries, with higher

concentration in the financial sector.

Table 3 presents the results from the UK switch sample. For PPE, we find that 6% of

companies use fair value under UK-GAAP and 5% use fair value under IFRS. A large number of

switches occur for this asset group. Specifically, 44% of the companies that use fair value for at

least one asset class in PPE under UK GAAP switch to historical cost (for all asset classes) upon

the IFRS adoption. In contrast, only 1% of companies that use historical cost for all asset classes

under UK GAAP switch to fair value for at least one asset class upon IFRS adoption. The joint

evidence in both tables implies that, almost uniformly, the market solution is given by historical

cost accounting.

An intriguing question is why 44% of the firms that used fair value under UK GAAP

switched to historical costs upon the IFRS adoption. IFRS and UK GAAP are very similar when

it comes to the valuation of PPE (see subsection 2.2 and Appendix A). Thus, the switches

observed upon the IFRS adoption are voluntary in the sense that IFRS did not force a switch to

historical cost. If managers find historical cost to be more beneficial, why did these firms not

15
switch to historical cost under UK GAAP?12 One explanation is that switching accounting

principles is uncommon and costly due to consistency requirements.13 The costs of switching

accounting principles include renegotiating contracts (which require consistency in GAAP),

convincing auditors that the new practice better reflects the underlying economics of the

company, and communicating and justifying the change to financial statement users. Most of

these costs are fixed (i.e., they are independent of the number of accounting principle changes)

so the incremental cost of voluntary changes is lower when combined with a mandatory change

such as IFRS adoption. Even if these managers did want to switch to historical cost before IFRS

adoption, the associated costs could have made switching unattractive. However, the observation

that a switch is more likely from fair value to historical cost than from historical cost to fair value

is inconsistent with a shift in the market solution towards fair value.

We do find, however, that after IFRS adoption, fair value is more common for investment

property, for which UK companies had to use fair value under local GAAP, than it is for PPE.

Nevertheless, managers of 23% of the companies reveal preferences for historical cost by

switching from fair value to historical cost once they are no longer constrained to the use of fair

value by the accounting regulation. Significant industry variation is present: whereas only 2% of

the financial companies switch to historical cost, 45% of the non-financial companies perform

the switch.

12
We contacted those non-financial companies that switched to historical cost and received several replies
indicating that IFRS was a convenient opportunity for them to make the switch.
13
Consistency in accounting policies across time is highly regarded by the accounting profession. Comparability is a
qualitative characteristic expressed in IASB’s Framework (paragraph 39): “. . . the measurement and display of the
financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and
over time for that entity.” In U.S. literature, consistency is expressed in several places, including the Accounting
Research Study No. 1 of the American Institute of Certified Public Accountants (postulate C-3). See Ball (1972) for
an extensive discussion of the accounting profession’s reliance on consistency.

16
4.2.2 Valuation practices in Germany

Table 4 documents the valuation practices in the German sample. As in the UK, we find

no use of fair value accounting for intangible assets in Germany. For PPE, 1% of companies

switch to fair value for at least one asset class upon IFRS adoption (note that under German

GAAP fair value was not allowed). Only one company applies fair value to all asset classes in

PPE, while all other companies use historical cost for at least one asset class. These findings

indicate that the market solution generally reveals preferences for historical cost accounting.

Consistent with prediction H1, fewer German than UK firms commit to fair value accounting.

For investment property, we find that the managers of 23% of the German companies

reveal preferences for fair value by switching from historical cost to fair value once they are no

longer constrained to historical cost by the accounting regulation. The German evidence is in

contrast to the 77% of UK companies that commit to fair value for investment property, which is

also in line with H1. However, we also observe substantial industry variation. Among financial

companies, 49% switch to fair value, while only 6% of the non-financial companies switch.

In summary, we find that a small number of companies use fair value accounting for at

least one asset class under PPE after the IFRS adoption. The absence of fair value accounting for

intangibles and its limited use for PPE in both the UK and Germany suggests that only a small

subset of managers perceive net benefits of fair value accounting in their setting. In contrast to

the expectation, there is virtually no shift towards fair value accounting for non-financial assets,

with the exception of investment property among German financial institutions. However, the

shift towards fair value for investment property is intuitively consistent with benefits of fair

value outweighing the costs for this asset class. Next, we provide evidence on H2 by exploiting

variation in the valuation practices within the PPE group.

17
4.2.3 Does the choice to use fair value for PPE vary with asset liquidity?

We collect evidence on which asset classes within the PPE asset group are recognized at

fair value as opposed to historical cost. Table 5 presents the distribution of the use of fair value

across the three asset classes. We find that 69 companies in the sample use fair value accounting

either before the mandatory adoption of IFRS, after the adoption, or both. Of these companies,

93% use fair value accounting for property. Only 3% use fair value for plant, and only 4% use

fair value for several asset classes in PPE. The distributions of fair value use in the UK and

Germany are rather similar. The evidence suggests that the application of fair value accounting

is, in practice, not only limited in terms of the number of companies using it, but also in terms of

the assets to which it is applied: fair value is largely limited to property. This result supports H2

and suggests that the existence of liquid markets decrease the costs of committing to fair value

accounting.

4.3 Regression analysis of the choice to use fair value.

In this section, we examine the determinants of the decision to use fair value accounting

by using a regression analysis. We first revisit H1 more formally and further test H3 and H4. Our

analysis draws on two different subsamples and controls for common company-specific

characteristics. First, we analyze the sample of companies that hold investment property. Second,

we examine the choice to use fair value for PPE. Table 6 reports the summary and correlation

statistics for variables used in this analysis. All variables are defined in Appendix C.

4.3.1 What are the determinants of the commitment to fair value for investment property?

IFRS gives managers of both German and UK companies an option to move to the asset

valuation method not previously available under local GAAP in these countries (recall that UK

companies face the first opportunity to switch to historical cost for investment property, whereas

18
in Germany the opposite is the case). In such a setting, observing switches from historical cost to

fair value in Germany and from fair value to historical cost in the UK is difficult to reconcile

with factors other than the existence of considerable net benefits associated with the alternative

accounting treatment (e.g., as opposed to opportunism).

Our sample consists of the 275 companies (124 UK companies; 151 German companies)

that hold investment property. Depending on the specification, additional data requirements limit

the sample further. We begin with a basic regression that examines whether accounting methods

vary based on country of domicile, and whether real estate is a primary industry,

FairIFRS  1UK   2UK * Sic65   3Germany   4Germany * Sic65  5 Leverage

  k Controlk   (1)

where UK (Germany) is an indicator variable that takes the value of one for UK

(German) companies and zero otherwise, Sic65 is an indicator that takes the value of one when a

company has the SIC code 65 (real estate) among its first five SIC codes and zero otherwise,

Leverage is one of the proxies for reliance on debt financing, and Control denotes other control

variables such as log of market capitalization and an IFRS early adoption dummy (Muller et al.

2011). H1 predicts that the institutional differences across the UK and Germany, as opposed to

accounting standards, influence the market solution to the choice of accounting practice. Thus,

under H1, we expect to find the country differences reflected by significant β1 and β3

coefficients. The coefficients β2 and β4 measure country differences when real estate is among a

company's primary business activities. Recall that the real estate industry is unique in that value

changes in its main assets (investment property) convey information about operating

performance. Consequently, H3 predicts that German real estate firms are more likely to switch

to fair value than German firms in other industries, while UK real estate firms are less likely to

19
switch to historical cost than UK firms in other industries. Finally, H4 indicates that leverage

proxies predict the choice of fair value.

Table 7 presents the regression estimates for several specifications nested in Equation (1).

The pseudo R-squared in Column (1) indicates that the baseline model specification explains a

substantial portion (34%) of the variation in the choice to use fair value. Consistent with H1, the

estimates indicate that companies domiciled in Germany are significantly more likely to use

historical cost after IFRS adoption (β3). This effect, however, is significantly smaller for

companies whose primary industries include real estate (β3 + β4), which in turn is consistent with

H3. Companies domiciled in the UK are more likely to use fair value under IFRS and this effect

is stronger (and more significant) for companies in the real estate business (β1 + β2), which also

supports H3. Observed switches to fair value among German real-estate companies and to

historical cost among UK non-real-estate companies, when companies are no longer constrained

by the local accounting regulation, suggest that the real estate industry has net firm-specific

benefits of fair value accounting for investment property. In sum, the evidence indicates that the

observed accounting practices vary with country institutions (H1), which supports the argument

in Ball (2006) that the application of the GAAP needs not be uniform under one set of standards,

and is specific to the institutional setting. The evidence is also consistent with fair value for

investment property being a superior measure of economic performance in the real estate

industry (H3).

Columns 2 through 6 of Table 7 examine whether the choice of fair value is positively

associated with reliance on debt as predicted by H4. The specification in Column 2 shows that

companies relying on debt financing more heavily are more likely to commit to fair value

accounting for investment property. This is consistent with the incremental costs of obtaining

20
reliable fair value estimates for financial reporting purposes being low when they are already

produced for financing purposes (Holthausen and Watts 2001). The other columns examine other

“leverage” proxies potentially used in debt contracts.14 We find that the ratio of total debt to

operating income has a positive relation to the use of fair value, while the coverage of interest

and the current ratios are negatively related to the use of fair value. The results are consistent

across different proxies for leverage and further support H4.

The split of leverage into its different components deserves some additional attention.

Prior literature suggests that companies may choose to revalue assets because the revaluations

allow them to relax covenants (Cotter and Zimmer 2003). While, as discussed earlier,

opportunistic motives are unlikely to explain the pre-commitment to fair value accounting that

comes with IFRS, we further investigate the role of opportunism by decomposing leverage into

its long- and short-term components, and add a proxy for reliance on convertible debt (i.e.,

column 3). We find that short-term leverage is as important as long-term debt in explaining the

use of fair value (both coefficients have similar economic magnitudes and exhibit no statistically

significant differences). The coefficient on convertible debt is also significantly positive. As

accounting-based covenants are less common in short-term and convertible-debt contracts, the

results are inconsistent with the conclusion that companies use fair value opportunistically to

avoid covenant violations.

To provide further evidence for H4, we examine whether fair value companies access

debt markets more frequently than historical cost companies following IFRS adoption in 2005. If

indeed the availability of reliable fair value estimates relates to debt financing activities, fair

value choices should predict more frequent debt market access. Based on Worldscope data for

14
We exclude leverage because these variables are highly correlated with leverage and therefore capture aspects of
the same construct.

21
2006 and 2007, we construct several proxies for debt financing. Specifically, we proxy for future

debt financing with the following variables: DebtIss1 (DebtIss2) indicates whether by 2007 total

debt (long-term debt) had increased by more than 10% of the current market value of assets;

FtrLev1 (FtrLev2) proxies for the level of future total debt (long-term debt) in 2007 while

controlling for the level of current debt in the regression; and DbtGrow1 (DbtGrow2) indicates

growth in total debt (long-term debt). We regress these financing proxies on the fair value

indicator variable and the controls for the company characteristics that include country, size,

leverage, and an SIC code 65 indicator.

Table 8, Columns (1) through (6) present regressions with the six proxies for debt

issuance used as the dependent variables. All proxies for debt issuance are statistically significant

and indicate a positive relation between fair value use and future debt financing. 15 The relation

between fair value use and future debt issuance is in line with the costs of recognizing fair value

estimates being lower when firms regularly access debt markets (H4).

4.3.2 What are the determinants of the commitment to fair value for PPE?

While the investment property sample offers richer variation, an understanding of the

choice of fair value for PPE, which is held by a much broader sample of firms, is potentially

more interesting. Unlike the investment property sample, we are able to hand-collect the data for

the fair value revaluation reserve from the annual reports (there is no revaluation reserve for

investment property, see Appendix A). This enables us to compute the book values of equity,

PPE, and total assets as if companies used historical cost. Thus, we can add book-to-market and

book leverage as explanatory variables without being concerned with a possible mechanical

15
While we have no strong prior for why equity market access should relate to fair value use, it can correlate with
debt market access. To rule out the possibility that our debt proxies are picking out equity issuance, we use two
proxies for future equity financing activity (first, an indicator of whether combined net proceeds of equity issuance
less proceeds from stock options exceed 10% of market value of current assets; and second, the ratio of net proceeds
to current market value of assets) and find that they are insignificantly related fair value use.

22
relation between book-to-market and fair value indicators. Similarly, this data also allows us to

use the ratio of PPE to total assets to examine whether PPE-heavy companies are more likely to

use fair value.

Table 9 presents the results of the logistic regression analysis for our pooled cross-

sectional sample. In line with the prior results for H1, German firms are significantly less likely

to use fair value for PPE (despite low economic magnitudes). The coefficient on book-to-market

indicates that companies with relatively low investment opportunities are more likely to use fair

value. Recall that H3 indeed suggests that fair value facilitates performance measurement for

companies lacking investment opportunities.

In line with the evidence for investment property, we find a positive and significant

association between market leverage as well as book leverage and the commitment to fair value

accounting. Further analysis in column (3) reveals that, once again, short-term debt is at least as

important as long-term debt in this association. The portion of convertible debt now exhibits no

significant relation with the fair value choice. As earlier, the evidence supports our conjecture

that the incremental costs of committing to fair value accounting decrease with the reliance on

debt financing.

Finally, two additional results are worth mentioning here. First, consistent with the costs

of fair value outweighing the benefits when an asset represents a small portion of the balance

sheet, we find a positive coefficient on PPE. Thus the likelihood of using fair value increases

with the proportion of PPE to total assets. Second, the positive coefficient on FairInvPr (Column

5) suggests that companies applying fair value to investment property are more likely to also

apply fair value to PPE. Controlling for this effect, however, does not alter our findings with

respect to leverage or book-to-market.

23
5. Conclusion

Whether fair value accounting dominates historical cost accounting in a free market for

accounting policies is an important question that has been subject to much controversy among

academics and regulators. We study the choice between fair value and historical cost for non-

financial assets when market forces, rather than regulators, determine the outcome of this choice.

In light of the long-standing debate over fair value accounting, understanding this choice is

useful from both regulatory and academic perspectives. Under the assumption of free market

discipline, the choices by management should be informative as to whether the net firm-specific

economic benefits associated with fair value accounting outweigh those of historical cost. In

addition, the advantage of our setting is that IFRS allows companies to choose between historical

cost and fair value accounting for non-financial assets, but requires pre-commitment to either

practice. This ex ante nature of the accounting choice strengthens managers’ incentives to choose

an accounting practice, which limits ex post opportunism (Watts and Zimmerman 1986).

We collect and analyze data on accounting policies for intangible assets, investment

property, and PPE for a sample of 1,539 companies. With very few exceptions, we find that fair

value is used exclusively for property. We find that 3% of the companies use fair value for

owner-occupied property, compared with 47% for investment property. The striking lack of

companies that use fair value for all other non-financial assets is inconsistent with large net firm-

specific benefits of fair value accounting relative to historical cost for those assets. The use of

fair value for property alone is likely explained by lower costs to reliably measure fair values in

the presence of relatively liquid property markets. Among the strongest cross-sectional

determinants of fair value for both investment property and PPE is the reliance on debt financing.

24
When fair value estimates are constructed for financing purposes, they are likely to be relatively

reliable, and the incremental costs of also recognizing them in financial reports are low.

Overall, our evidence indicates standard setters need to be careful in requiring fair value

accounting for certain asset classes. We find that, for non-financial asset classes, the market

solution for the choice between the two alternative valuation methods lies with historical cost

accounting: firms’ managers, who represent outside stakeholders, generally reveal preferences

for historical cost accounting for a broad range of non-financial assets. The limited cross-

sectional variation in the choice between fair value and historical cost does indicate that market

forces influence preferences. The evidence broadly suggests that managers’ resistance to the use

of fair value is likely to be driven by the costs of establishing reliable fair value estimates rather

than a disagreement with standard setters on the potential benefits of fair value accounting – firm

managers appear to view fair value accounting for non-financial assets as costly. As a result,

unless compelling reasons exist to believe that there is a market failure (i.e., the market fails to

discipline management or valuation choices involve externalities), then fair value regulation can

impose costs on the economy.

25
References
Aboody, D., Barth, M. E., & Kasznik, R. 1999. Revaluations of fixed assets and future firm
performance, Evidence from the UK. Journal of Accounting and Economics, 26 (1–
3),149–178.
Amir, E., Harris, T. S., & Venuti, E. K. 1993. A Comparison of the value-relevance of U.S.
versus Non-U.S. GAAP accounting measures using Form 20-F reconciliations. Journal of
Accounting Research (Supplement 1993), 230–64.
ARB 1940. Committee on Accounting Procedure. ‘Depreciation on appreciation’. Accounting
Research Bulletin No. 5. The Journal of Accountancy, 69 (6), 461–7.
Ball, R. 1972. Changes in accounting techniques and stock prices. Journal of Accounting
Research, 10(2) (1),1–38.
Ball, R. 1989. The firm as a specialist contracting intermediary, Application to accounting and
auditing. University of Rochester working paper.
Ball, R. 2006. International Financial Reporting Standards (IFRS): Pros and cons for investors.
Accounting and Business Research, 36 (Special Issue),5–27.
Ball, R., & Shivakumar, L. 2006. The role of accruals in asymmetrically timely gain and loss
recognition. Journal of Accounting Research, (44), 207–242.
Barth, M. E., Beaver, W. H., & Landsman, W. R. 2001. The relevance of the value relevance
literature for financial accounting standard setting: Another view. Journal of Accounting
and Economics, 31 (Issue 1–3),77–104.
Barth, M. E., & Clinch, G. 1996. International accounting differences and their relation to share
prices: Evidence from U.K., Australian, and Canadian firms. Contemporary Accounting
Research, 13,135–170.
Barth, M. E., & Clinch, G.. 1998. Revalued financial, tangible, and intangible assets, Association
with share prices and non-market-based value estimates. Journal of Accounting Research,
36,199–233.
Brown, P., Izan, H. Y., & Loh, A. L. 1992. Fixed asset revaluations and managerial incentives.
Abacus, 28 (1),36–57.
Cairns, D., Massoudi, D. R., Taplin, T., & Tarca, A. 2011. IFRS fair value measurement and
accounting policy choice in the United Kingdom and Australia. The British Accounting
Review, (1), 1–21.
Citron, D. B. 1992. Accounting measurement rules in UK bank loan contracts. Accounting and
Business Research, (23), 21–30.
Cotter, J., & Zimmer, I. 1995. Asset revaluations and assessment of borrowing capacity. Abacus,
31(2), pp. 136–151.
Cotter, J., & Zimmer, I. 2003. Disclosure versus recognition: The case of asset revaluations.
Asia-Pacific Journal of Accounting and Economics, 10 (1), 81-99.
Danbolt, J., & Rees, W. 2008. An experiment in fair value accounting: UK investment vehicles.
European Accounting Review, 17 (2),271 – 303.
Easton, P. D., Eddey, P. H., & Harris, T. S. 1993. An investigation of revaluations of tangible
long-lived assets. Journal of Accounting Research, 31 (3),1–38.
Fabricant, S. 1936. Revaluations of fixed assets, 1925 – 1934. National Bureau of Economic
Research Bulletin 62.
Fields, T. D., Lys, T. Z., & Vincent, L. 2001. Empirical research on accounting choice. Journal
of Accounting and Economics, 31, 255–307.
Graham, B., and D. L. Dodd 1951. Security analysis (3rd ed.). New York: McGraw-Hill.

26
Hail, L., Leuz, C., & Wysocki, P. D. 2010. Global accounting convergence and the potential
adoption of IFRS by the United States (Part 1): Conceptual underpinnings and economic
analysis. Accounting Horizons, 24 (3), 355-394.
Herrmann, D., Saudagaran, S. M., & Thomas, W. B. 2006. The quality of fair value measures for
property, plant, and equipment. Accounting Forum, 30 (1),43–59.
Holthausen, R. W., & Watts, R. L. 2001. The relevance of the value-relevance literature for
financial accounting standard setting. Journal of Accounting and Economics, 31 (1–3),3–
75.
IASB. 2006. Preliminary views on an improved conceptual framework for financial reporting,
The objective of financial reporting and qualitative characteristics of decision-useful
financial reporting. Discussion paper, IASB July 2006.
Jensen, M. C., & Meckling W. H. 1976. Theory of the firm: Managerial behavior, agency costs
and ownership structure. Journal of Financial Economics, 3 (4),305–360.
Johnson, L. T. 2005. Relevance and reliability. The FASB Report.
Kothari, S. P., Ramanna, K., & Skinner, D. 2010. Implications for GAAP from an analysis of
positive research in accounting. Journal of Accounting and Economics, 50, 246–286.
Laux, C., & Leuz, C. 2009. The crisis of fair-value accounting, Making sense of the recent
debate. Accounting, Organizations and Society, 34 (6–7),826–834.
Leftwich, R. 1983. Accounting information in private markets: Evidence from private lending
agreements. The Accounting Review, 58, 23–42.
Leuz, C., & Wüstemann, J. 2004. The Role of Accounting in the German Financial System. In J.
Krahnen and R. H. Schmidt(Eds.), The German financial system, Oxford: Oxford
University Press.
Muller, K. A. III 1999. An examination of the voluntary recognition of acquired brand names in
the United Kingdom. Journal of Accounting and Economics, 26 (1–3),179–191.
Muller, K. A. III, & Riedl, E. J. 2002. External monitoring of property appraisal estimates and
information asymmetry. Journal of Accounting Research, 40 (3),865–881.
Muller, K. A. III, Riedl, E. J., & Sellhorn, T. 2011. Mandatory fair value accounting and
information asymmetry: Evidence from the European Real Estate Industry. Management
Science, 57, 1138–1153.
Paton, W. A., ed. 1932. Accountants' Handbook. Vol. 2. New York: The Ronald Press Company.
Paton, W. A., & Dixon, R. L. 1958. Essentials of accounting. London: MacMillan.
Ramanna, K., & Watts, R. L. 2012. Evidence on the use of unverifiable estimates in required
goodwill impairment. Review of Accounting Studies, forthcoming.
Schipper, K. 2005. Fair values in financial reporting. http,//fars.org/2005AAAFairValue
KSchipper.pdf.
Sharpe, I. G., & Walker, R. G. 1975. Asset revaluations and stock market prices. Journal of
Accounting Research, 13 (2),293–310.
Shleifer, A., & Vishny, R. W. 1992. Liquidation values and debt capacity: A market equilibrium
approach. The Journal of Finance, 47 (4),1343–1366.
Standish, P. E. M., & Ung, S.-I. 1982. Corporate signaling, asset revaluations and the stock
prices of British companies. The Accounting Review, 57(4), pages 701-715.
Watts, R. L. 1977. Corporate financial statements, a product of the market and political process.
Australian Journal of Management, 2, 53–75.
Watts, R. L. 2006. What has the invisible hand achieved?, MIT Sloan School of Management
working paper.

27
Watts, R. L., & Zimmerman J. L. 1986. Positive accounting theory, In editors (Eds.),
Contemporary topics in accounting series. New Jersey: Prentice-Hall.
Weston, J. F. 1953. Revaluations of fixed assets. The Accounting Review, 18, 489–490.
Whittred, G., & Chan Y. K. 1992. Asset revaluations and the mitigation of underinvestment.
Abacus, 28 (1),58–74.
Zeff, S. A. 1995. A perspective on the U.S. public/private-sector approach to the regulation of
financial reporting. Accounting Horizons, 1, 52–70.
Zeff, S. A. 2007. The SEC rules historical cost accounting: 1934 to the 1970s. Accounting and
Business Research, Supplement 1, 1–14.

28
Appendix A: The accounting treatment of long-term non-financial assets under UK GAAP,
German GAAP, and IFRS.

In this appendix we describe the accounting treatment of long-term non-financial

assets—investment property, PPE, and intangible assets—under UK-GAAP, German GAAP,
and IFRS. For brevity, we use the term historical cost to describe historical cost adjusted for
depreciations, amortizations, and impairments.

Accounting for investment property

Investment property consists of land or buildings held to generate rental income or capital
appreciation. Under German GAAP, companies must value investment property at historical
cost, while under UK-GAAP, companies are required to use fair value (German HGB, para. 253,
and SSAP 19). Net income is unaffected by upward revaluations of this asset group under UK-
GAAP, as they are credited to the revaluation reserve. IFRS offers companies the choice between
recognizing investment property at historical cost or fair value (IAS 40). Under IFRS, if a
company chooses to recognize investment property at historical cost, it must systematically
depreciate the acquisition costs and disclose the investment property's fair value in the notes
accompanying the financial statements. In contrast, if a company chooses to apply fair value,
changes in the investment property's value become part of the operating income and the assets
are not subject to depreciation.

Accounting for property, plant, and equipment (PPE)

The only valuation method for PPE permitted under German GAAP is historical cost less
depreciations (German HGB, para. 253). Under both IFRS and UK-GAAP, PPE is initially
recognized at cost but at each subsequent balance sheet date is valued at either historical cost or
fair value (IAS 16 and FRS 15). In either case, these assets are subject to depreciation. When fair
value is applied, positive changes in an asset's value are credited to the revaluation reserve,
which constitutes part of shareholders’ equity. Revaluations, therefore, only affect net income
through future depreciation charges (unlike for investment property). Finally, under IFRS, the
choice of valuation method must be consistent for all assets in the same asset class (IAS16.29).

Accounting for intangible assets

Under German GAAP, historical cost is the only valuation method permitted for
intangible assets (German HGB, para. 253). Under both UK-GAAP and IFRS, however,
intangible assets are to be carried at either historical cost or fair value less any amortization and
impairment charges (IAS 38 and FRS 10). Under fair value, the accounting treatment is similar
to that of PPE; that said, a company may only apply fair value to an intangible asset in the rare
circumstances where the intangible asset has a readily ascertainable market value from an active
market. The definition of an active market is rather narrow, and for many intangible assets, such
as brands, patents, and trademarks, it is non-existent, due to their uniqueness and the specificity
of their application (IAS38.78). Hence, for most intangible assets, managers are in practice
restricted to historical costs accounting and the valuation choice for intangibles therefore cannot
be considered free to the same extent as it can for investment property and PPE.

29
Appendix B: Examples of accounting practice

This appendix presents examples of fair value and historical cost accounting from the accounting
policy section of annual reports of companies in our samples. Panel A presents an example of a
switch from fair value under UK-GAAP to historical cost under IFRS. Panel B presents an
example of fair value accounting under both UK-GAAP and IFRS. Panel C presents an example
of a German company that uses fair value accounting under IFRS.

Panel A: Switch from fair value to historical cost

Annual report according to UK-GAAP for 2004
AMEC plc annual report and accounts 2004 (page 67)
12 Tangible assets (continued)
All significant freehold and long leasehold properties were externally valued as at 31 December
2004 by CB Richard Ellis Limited in accordance with the Appraisal and Valuation Manual of the
Royal Institute of Chartered Surveyors.
For the United Kingdom, the basis of revaluation was the existing use value for properties
occupied by group companies and the market value for those properties without group
occupancy. For properties outside the United Kingdom, appropriate country valuation standards
were adopted that generally reflect market value.
No provision has been made for the tax liability that may arise in the event that certain properties
are disposed of at their revalued amounts.
The amount of land and buildings included at valuation, determined according to the historical
cost convention, was as follows:
Group Group Company Company
2004 2003 2004 2003
£ million £ million £ million £ million
Cost 39.2 46.4 9.3 8.6
Depreciation (10.61) (13.9) (2.5) (1.7)
Net book value 26.6 32.5 6.8 6.9

Annual report according to IFRS for 2005

AMEC plc annual report and accounts 2005 (page 102)
IAS 16 Property, plant and equipment
Under UK-GAAP, AMEC’s policy was to revalue freehold and long leasehold property on a
regular basis. Under IAS 16, AMEC has opted to carry property, plant, and equipment at cost
less accumulated depreciation and impairment losses. As permitted by IFRS 1, AMEC has
frozen the UK-GAAP land and buildings revaluations as at 1 January 2004 by ascribing the
carrying value as deemed cost. The impact of this change in policy is as follows:
 the revaluation reserve is reclassified into retained earnings as at the date of transition;
 the results of the external revaluation as at 31 December 2004 are reversed, reducing the
value of property, plant and equipment as at 31 December 2004 by £9.6 million; and

30
  as part of the 2004 external revaluation, certain properties were revalued downwards.
Under UK-GAAP, these deficits were charged against previous revaluations held in the
revaluation reserve. Under IFRS, these downward revaluations have been taken as
indicators that the value of the relevant properties is impaired and as such, they have been
charged to the income statement as impairment charges in 2004. This reduces the profit
for the year ended 31 December 2004 and the value of property, plant and equipment as
at 31 December 2004 by £1.8 million.

Panel B: Fair value under both UK-GAAP and IFRS

Annual report according to UK-GAAP for 2004
The Wolverhampton & Dudley Breweries, PLC Annual report 2005 (page 44).
(e) Tangible fixed assets
 Freehold and leasehold properties are stated at valuation or at cost. Plant, furnishings,
equipment, and other similar items are stated at cost.
 Freehold buildings are depreciated to their residual value on a straight line basis over 50
years.
 Other tangible fixed assets are depreciated to their residual value on a straight line basis
at rates calculated to provide for the cost of the assets over their anticipated useful lives.
Leasehold properties are depreciated over the lower of the lease period and 50 years and
other tangible assets over periods ranging from three to 15 years.
 Own labor directly attributable to capital projects is capitalized.
Valuation of properties: Trading properties are revalued professionally by independent valuers
on a five-year rolling basis. When a valuation or expected proceeds are below current carrying
value, the asset concerned is reviewed for impairment. Impairment losses are charged directly to
the revaluation reserve until the carrying amount reaches historical cost. Deficits below historical
cost are charged to the profit and loss account except to the extent that the value in use exceeds
the valuation, in which case this is taken to the revaluation reserve. Surpluses on revaluation are
recognized in the revaluation reserve, except to the extent that they reverse previously charged
impairment losses, in which case they are recorded in the profit and loss account. Any negative
valuations are accounted for as onerous leases and included within provisions (see note 20).

Annual report according to IFRS for 2005

The Wolverhampton & Dudley Breweries, PLC Annual report 2006 (page 46).
Property, plant and equipment
 Freehold and leasehold properties are stated at valuation or at cost. Plant, furnishings,
equipment, and other similar items are stated at cost.
 Depreciation is charged to the income statement on a straight-line basis to provide for the
cost of the assets less residual value over their useful lives.
 Freehold and long leasehold buildings are depreciated to residual value over 50 years.
 Short leasehold properties are depreciated over the life of the lease.
 Other plant and equipment is depreciated over periods ranging from 3 to 15 years.
 Own labor directly attributable to capital projects is capitalized.

31
  Land is not depreciated.
Valuation of properties - Properties are revalued by qualified valuers on a regular basis using
open market value so that the carrying value of an asset does not differ significantly from its fair
value at the balance sheet date. When a valuation is below current carrying value, the asset
concerned is reviewed for impairment. Impairment losses are charged to the revaluation reserve
to the extent that a previous gain has been recorded, and thereafter to the income statement.
Surpluses on revaluation are recognized in the revaluation reserve, except where they reverse
previously charged impairment losses, in which case they are recorded in the income statement.

Panel C: Fair value accounting by German company

Annual report according to IFRS for 2005
Hypo Real Estate Group, Annual report 2006 (page 96)
12 Property, plant, and equipment
Property, plant, and equipment is normally shown at cost of purchase or cost of production. As
an exception to this rule, land and buildings are shown with their fair value in accordance with
IAS 16. The carrying amounts – if the assets are subject to wear and tear – are diminished by
depreciation in accordance with the expected service life of the assets. In the case of fittings in
rented buildings, the contract duration taking account of extension options is used as the basis of
this contract duration is shorter than the economic life.

Appendix C: Variable definitions

Fair_IFRS = one if the company uses fair value after adoption of IFRS, and zero otherwise.
UK = one if a company is domiciled in the UK, and zero otherwise.
UkSic65 = one if a company has SIC 65 (real estate) among its first five SIC codes and is
domiciled in the UK, and zero otherwise.
Germany = one if a company is domiciled in Germany, and zero otherwise.
GermanySic65 = one if a company has SIC 65 (real estate) among its first five SIC codes and is
domiciled in Germany, and zero otherwise.
Early = one if the company adopted IFRS before 2005, and zero otherwise.
Size = log of market value of equity.
PPEA = property, plant, and equipment less revaluation reserve divided by total assets less
revaluation reserve.
MktLev = total liabilities divided by market value of assets (defined as book value of liabilities
plus market value of equity) as of December 2005.
MktLevLong = long-term debt divided by market value of assets (liabilities plus market value of
equity) as of December 2005.
MktLevShort = short-term liabilities defined as total liabilities less long-term debt divided by
market value of assets (liabilities plus market value of equity) as of December 2005.

32
LevBook = book leverage defined as total liabilities divided by total assets net of fair value
revaluation reserve.
LevBookLong = long-term debt divided by total assets net of fair value revaluation reserve.
LevBookShort = ratio of total liabilities minus long-term debt to total assets net of fair value
revaluation reserve.
Convertible = ratio of convertible debt to long-term debt.
DebtToOi = total liabilities divided by operating income.
Coverage = operating income divided by interest expense.
Current = current assets divided by current liabilities.
Dividend = one if company pays dividends, and zero otherwise.
FairInvPr = one if company holds investment property recorded at fair value, and zero
otherwise.
DbtIss1 = change in total liabilities that took place from 2005 to 2007 scaled by beginning-of-
period market value of assets (liabilities plus market value of equity).
DbtIss2 = change in long-term debt that took place from 2005 to 2007 scaled by beginning-of-
period market value of assets (liabilities plus market value of equity).
FtrLev1 = total liabilities as of 2007 scaled by beginning-of-period market value of assets
(liabilities plus market value of equity).
FtrLev2 = long-term debt as of 2007 scaled by beginning-of-period market value of assets
(liabilities plus market value of equity).
DbtGrow1 = logarithmic growth in total liabilities from 2005 to 2007.
DbtGrow2 = logarithmic growth in long-term debt from 2005 to 2007.
EqIss1 = dummy variable; one if total net proceeds from issuance of common and preferred
stock less proceeds from stock options over 2006 and 2007 exceeded 10% of 2005 market
value of assets (liabilities plus market value of equity), and zero otherwise.
EqIss2 = net proceeds from issuance of common and preferred stock less proceeds from stock
options combined over 2006 and 2007 and scaled by 2005 market value of assets (liabilities
plus market value of equity).
Note: Unless otherwise stated, variables are measured as of December 2005 using the
Worldscope database.

Appendix D: Fair value accounting and the book value of assets

Companies that follow historical cost accounting must periodically test their assets for
impairment. An asset is considered impaired under the IFRS when its carrying amount is higher
than (i) its fair value less costs to sell and (ii) the present value of the future cash flows it is
expected to generate (IAS36.18). Thus, under historical cost accounting, companies in practice
value assets close to fair value if the depreciated historical costs exceed the fair value. In
contrast, under fair value accounting, companies revalue assets either upward or downward

33
depending on the change in the fair value estimate. This revaluation implies that the book values
of assets (equity) are likely to be higher for companies that use fair value accounting. We
emphasize that one should not interpret these results as causal because they are conditional on
the company’s decision to use fair value. To provide evidence on the differences in balance sheet
amounts of fair value versus historical cost companies, we carry out the following analysis.

Table 1D compares the book value of total assets (book value of equity) divided by the market
value of total assets (market value of equity) for companies that use fair value with that of
companies that use only historical cost. We compute the market value of total assets by the sum
of the market value of equity and the book value of liabilities. Panel A of Table 1D presents the
evidence for investment property, and Panel B of Table 1D presents the evidence for property,
plant, and equipment (PPE). Each company that recognizes PPE at fair value is matched on
country, industry, and market capitalization with a company that recognizes all assets at
historical cost. For investment property, we include all of the companies that hold investment
property because there is no pronounced imbalance between the fair value and historical cost
subgroups. We find that, on average, the ratio of book value of total assets to market value of
total assets is 16% higher for companies that recognize investment property at fair value; the
ratio of book value of equity to market value of equity is 27% higher. Among companies that
apply fair value to PPE, we find that the ratio of the book value of total assets to the market value
of total assets and the ratio of the book value of equity to the market value of equity are,
respectively, 31% and 87% higher than those of matched companies that use only historical cost.
The differences in the book values of assets and equity in both the investment property and the
PPE samples are all significant at the 1% level. We also examine how the return on assets (ROA)
differs between fair value and historical cost companies. We find a lower ROA in the PPE
sample among companies that recognize assets at fair value. In the investment property sample,
we also find a lower ROA among companies that use fair value accounting; this difference,
however, is statistically insignificant. [It is not surprising that fair value accounting for property
decreases ROA because while, on average, fair value accounting increases the book value of
assets, upward revaluations do not affect the net income. For investment property this effect is
smaller because upward revaluations increase both net income and total assets (see Appendix
A).]

[Insert Table 1D here]

The evidence in Table 1D indicates that the decision to use the fair value method is associated
with economically significant differences in companies’ balance sheets, which makes companies
that use fair value accounting appear less conservative in terms of their book-to-market ratios.

34
Figure 1: The accounting treatment of long-term non-financial assets under German GAAP,
UK GAAP, and IFRS

German GAAP UK GAAP IFRS

Asset type Balance Income statement Balance Income statement Balance Income statement
sheet sheet sheet

Property, plant and HC Depreciations / HC or FV Both HC and FV: HC or FV Both HC and FV:
equipment (PPE) impairments / Depreciations / Depreciations /
realized gains and impairments / impairments / realized
losses realized gains and gains and losses
losses

Investment HC Depreciations / FV Depreciations / HC (with If HC:

property impairments / impairments / disclosure of Depreciations /
realized gains and realized gains or FV in impairments / realized
(land and buildings losses losses footnotes) or gains and losses
held for rental FV
income or capital
appreciation) If FV:
Gain and losses in
operating income
regardless of realized
or unrealized

Intangibles HC Depreciations / HC or FV Both HC and FV: HC or FV (if Both HC and FV:

impairments / (if active Depreciations / active market Depreciations /
realized gains and market impairments / exists) impairments / realized
losses exists) realized gains or gains or losses
losses

Note: FV is defined as fair value accounting and HC is defined as historical cost accounting adjusted for depreciations, amortizations, and
impairments.

35
Table 1: Sample selection process
Table 1 presents the sample selection process and industry distribution. Panel A presents the selection process for
the UK samples. The cross-sectional sample consists of companies for which we can identify an annual report
according to IFRS. Our switch sample further requires that an annual report (according to UK-GAAP) be available
prior to mandatory IFRS adoption. Panel B presents the selection process for the German sample. To be included in
the German sample, companies must have available an annual report according to IFRS. Percentages are rounded
and thus may not exactly sum to 100%.

Panel A: UK samples
Active companies (FBRIT, March 2008) 2,312
Inactive companies (DEADUK, March 2008) + 5,597
UK listed companies in Worldscope 7,909

Companies that Worldscope does not classify as complying with

IFRS in 2005 or 2006 (mainly inactive companies) – 6,464
IFRS companies 1,445

Companies not domiciled in the UK – 270

UK companies subject to mandatory IFRS 1,175

Companies for which we cannot identify an IFRS annual report

or companies with more than one security listed on LSE – 241
UK Cross-sectional Sample 934

Companies for which we cannot identify a UK GAAP annual report – 231

UK Switch Sample 703
Industry distribution in the UK samples
UK UK UK UK
Worldscope IFRS Cross-sectional Switch
No. Industry name All All Excl. N/A
obs. % % Obs. % Obs. % Obs. %
N/A No industry classification 3,139 40%
13 Aerospace 19 0% 0% 11 1% 5 1% 5 1%
16 Apparel 42 1% 1% 7 1% 7 1% 6 1%
19 Automotive 44 1% 1% 6 1% 6 1% 5 1%
22 Beverages 50 1% 1% 11 1% 7 1% 5 1%
25 Chemicals 106 1% 2% 24 2% 20 2% 18 3%
28 Construction 234 3% 5% 65 5% 54 6% 49 7%
31 Diversified 48 1% 1% 8 1% 6 1% 6 1%
34 Drugs, Cosmetics, & Health care 178 2% 4% 52 4% 44 5% 31 4%
37 Electrical 55 1% 1% 13 1% 10 1% 6 1%
40 Electronics 539 7% 11% 136 11% 109 12% 90 13%
43 Financial 674 9% 14% 187 16% 140 15% 105 16%
46 Food 107 1% 2% 27 2% 23 2% 21 3%
49 Machinery & equipment 141 2% 3% 22 2% 22 2% 16 2%
52 Metal producers 213 3% 4% 59 6% 49 5% 23 3%
55 Metal product manufacturers 63 1% 1% 15 1% 12 1% 11 2%
58 Oil, gas, coal, & related services 251 3% 5% 64 6% 52 6% 29 4%
61 Paper 44 1% 1% 9 1% 6 1% 5 1%
64 Printing & publishing 92 1% 2% 25 2% 19 2% 16 2%
67 Recreation 294 4% 6% 51 4% 41 4% 32 5%
70 Retail 211 3% 4% 56 4% 51 5% 43 6%
73 Textile 53 1% 1% 10 1% 8 1% 6 1%
76 Tobacco 10 0% 0% 6 0% 3 0% 3 0%
79 Transportation 73 1% 2% 19 2% 17 2% 14 2%
82 Utilities 232 3% 5% 62 6% 31 3% 23 3%
85 Other industries 997 13% 21% 230 18% 192 21% 135 19%
Total 7,909 100% 100% 1,175 100% 934 100% 703 100%
Table 1 continued

Panel B: The German sample

Active companies (March 2008) 1,437

Inactive companies (March 2008) + 10,126
German listed companies in Worldscope 11,563
Companies that Worldscope does not classify as complying with
IFRS in 2005 or 2006 (mainly inactive companies) – 10,117
IFRS companies 1,446
Companies not domiciled in Germany – 635
German companies subject to mandatory IFRS 811

Companies for which we cannot identify an IFRS annual report – 206

German sample 605

Industry distribution in the German sample

German German German
Worldscope IFRS Sample
No. Industry name All All Excl. N/A
obs. % % Obs. % Obs. %
N/A No industry classification 2,192 19% N/A N/A N/A N/A N/A
13 Aerospace 25 0% 0% 2 0% 1 0%
16 Apparel 72 1% 1% 19 2% 11 2%
19 Automotive 99 1% 1% 18 2% 10 2%
22 Beverages 93 1% 1% 11 1% 9 1%
25 Chemicals 207 2% 2% 34 4% 16 3%
28 Construction 235 2% 3% 34 4% 22 4%
31 Diversified 74 1% 1% 12 1% 8 1%
34 Drugs, Cosmetics, & Health care 610 5% 7% 36 4% 25 4%
37 Electrical 143 1% 2% 21 3% 13 2%
40 Electronics 1,832 16% 20% 95 12% 78 13%
43 Financial 1,430 12% 15% 131 16% 96 16%
46 Food 154 1% 2% 11 1% 8 1%
49 Machinery & equipment 324 3% 3% 69 9% 54 9%
52 Metal producers 251 2% 3% 1 0% 1 0%
55 Metal product manufacturers 108 1% 1% 10 1% 6 1%
58 Oil, gas, coal, & related services 323 3% 3% 9 1% 5 1%
61 Paper 69 1% 1% 9 1% 6 1%
64 Printing & publishing 78 1% 1% 6 1% 6 1%
67 Recreation 371 3% 4% 30 4% 25 4%
70 Retail 350 3% 4% 23 3% 17 3%
73 Textile 46 0% 0% 8 1% 5 1%
76 Tobacco 16 0% 0% 0 0% 0 0%
79 Transportation 148 1% 2% 10 1% 7 1%
82 Utilities 497 4% 5% 25 3% 20 3%
85 Other industries 1,816 16% 19% 187 23% 156 26%
Total 11,563 100% 100% 811 100% 605 100%
Table 2: UK companies' valuation practices after IFRS adoption
Table 2 presents the valuation practices among companies in the UK cross-sectional sample (defined in Table 1). The
industry classification is based on Worldscope's major industry groups. The "With PPE" ("With intan.") column presents
for each industry how many companies have property, plant, and equipment (intangible assets). The historical cost (fair
value) columns present how many companies use historical cost (fair value) for at least one asset class within property,
plant, and equipment and intangible assets.

Cross- Property, Plant, and Equipment Intangible assets

No. Industry name sectional With Historical Fair With Historical Fair
sample PPE cost value intan. cost value
No. No. % No. % No. No. % No. %
13 Aerospace 5 5 5 100% 0 0% 5 5 100% 0 0%
16 Apparel 7 7 7 100% 1 14% 7 7 100% 0 0%
19 Automotive 6 6 6 100% 0 0% 6 6 100% 0 0%
22 Beverages 7 7 7 100% 1 14% 7 7 100% 0 0%
25 Chemicals 20 20 20 100% 1 5% 20 20 100% 0 0%
28 Construction 54 54 54 100% 4 7% 39 39 100% 0 0%
31 Diversified 6 6 6 100% 0 0% 6 6 100% 0 0%
34 Drugs, Cosmetics, & Health care 44 44 44 100% 0 0% 44 44 100% 0 0%
37 Electrical 10 10 10 100% 0 0% 10 10 100% 0 0%
40 Electronics 109 107 107 100% 1 1% 100 100 100% 0 0%
43 Financial 140 118 118 100% 16 14% 68 68 100% 0 0%
46 Food 23 23 23 100% 2 9% 23 23 100% 0 0%
49 Machinery & equipment 22 22 22 100% 1 5% 22 22 100% 0 0%
52 Metal producers 49 44 44 100% 1 2% 44 44 100% 0 0%
55 Metal product manufacturers 12 12 12 100% 1 8% 12 12 100% 0 0%
58 Oil, gas, coal, & related services 52 52 52 100% 1 2% 50 50 100% 0 0%
61 Paper 6 6 6 100% 0 0% 6 6 100% 0 0%
64 Printing & publishing 19 19 19 100% 0 0% 16 16 100% 0 0%
67 Recreation 41 41 41 100% 1 2% 36 36 100% 0 0%
70 Retail 51 50 50 100% 3 6% 40 40 100% 0 0%
73 Textile 8 8 8 100% 1 13% 8 8 100% 0 0%
76 Tobacco 3 3 3 100% 0 0% 3 3 100% 0 0%
79 Transportation 17 17 17 100% 1 6% 17 17 100% 0 0%
82 Utilities 31 31 31 100% 0 0% 31 31 100% 0 0%
85 Other industries 192 191 191 100% 6 3% 185 185 100% 0 0%
Total Sample 934 903 903 100% 42 5% 805 805 100% 0 0%
Table 3: UK companies’ valuation practices before and after IFRS adoption
Table 3 presents valuation practices among companies in the UK switch sample (defined in Table 1). The industry
classification is based on Worldscope's major industry groups. The "With PPE" ("With inv. prop.") column presents for
each industry how many companies have property, plant, and equipment (investment property). The historical cost (fair
value) columns present how many companies use historical cost (fair value) for at least one asset class within property,
plant, and equipment and intangible assets.
1
As a percentage of companies that use fair value accounting under UK GAAP.
2
As a percentage of companies that use only historical cost under UK GAAP.
3
Given that UK GAAP requires that investment property be recognized at fair value, the application of historical cost always
constitutes a switch. Therefore, in Table 3, we use the UK cross-sectional sample for investment property.

Property, plant, and equipment Investment property

No. Industry name Switch With Fair value Switch to Switch to Cross- With Keep Move to
sample PPE UK IFRS historical cost fair value sectional inv. fair value historical cost
No. % No. % No. % 1 No. % 2 sample 3 prop. No. % No. %
13 Aerospace 5 5 0 0% 0 0% 0 N/A 0 0% 5 2 1 50% 1 50%
16 Apparel 6 6 1 17% 1 17% 0 0% 0 0% 7 0 0 N/A 0 N/A
19 Automotive 5 5 1 20% 0 0% 1 100% 0 0% 6 1 1 100% 0 0%
22 Beverages 5 5 1 20% 1 20% 0 0% 0 0% 7 1 0 0% 1 100%
25 Chemicals 18 18 1 6% 1 6% 0 0% 0 0% 20 0 0 N/A 0 N/A
28 Construction 49 49 6 12% 4 8% 3 50% 1 2% 54 10 7 70% 3 30%
31 Diversified 6 6 0 0% 0 0% 0 N/A 0 0% 6 1 1 100% 0 0%
34 Drugs, Cosmetics, & Health care 31 31 1 3% 0 0% 1 100% 0 0% 44 0 0 N/A 0 N/A
37 Electrical 6 6 0 0% 0 0% 0 N/A 0 0% 10 1 1 100% 0 0%
40 Electronics 90 89 1 1% 1 1% 0 0% 0 0% 109 3 1 33% 2 67%
43 Financial 105 90 13 14% 10 11% 6 46% 3 4% 140 66 65 98% 1 2%
46 Food 21 21 2 10% 1 5% 1 50% 0 0% 23 2 1 50% 1 50%
49 Machinery & equipment 16 16 0 0% 1 6% 0 N/A 1 6% 22 1 0 0% 1 100%
52 Metal producers 23 22 0 0% 0 0% 0 N/A 0 0% 49 1 0 0% 1 100%
55 Metal product manufacturers 11 11 0 0% 1 9% 0 N/A 1 9% 12 0 0 N/A 0 N/A
58 Oil, gas, coal, & related services 29 29 1 3% 1 3% 0 0% 0 0% 52 3 3 100% 0 0%
61 Paper 5 5 0 0% 0 0% 0 N/A 0 0% 6 1 0 0% 1 100%
64 Printing & publishing 16 16 0 0% 0 0% 0 N/A 0 0% 19 0 0 N/A 0 N/A
67 Recreation 32 32 2 6% 1 3% 1 50% 0 0% 41 1 0 0% 1 100%
70 Retail 43 42 4 10% 2 5% 2 50% 0 0% 51 9 1 11% 8 89%
73 Textile 6 6 1 17% 1 17% 0 0% 0 0% 8 2 1 50% 1 50%
76 Tobacco 3 3 0 0% 0 0% 0 N/A 0 0% 3 0 0 N/A 0 N/A
79 Transportation 14 14 0 0% 1 7% 0 N/A 1 7% 17 2 2 100% 0 0%
82 Utilities 23 23 1 4% 0 0% 1 100% 0 0% 31 3 1 33% 2 67%
85 Other industries 135 135 8 6% 4 3% 4 50% 0 0% 192 14 10 71% 4 29%
Total Sample 703 685 44 6% 31 5% 20 44% 7 1% 934 124 96 77% 28 23%

39
Table 4: German companies’ valuation practices after IFRS adoption
Table 4 presents the valuation practices among companies in the German sample (defined in Table 1). The industry
classification is based on Worldscope's major industry groups. The "With PPE" ("With inv. prop.") ["With intan."] column
presents for each industry how many companies have property, plant, and equipment (investment property) [intangible
assets]. The historical cost (fair value) columns present how many companies use historical cost (fair value) for at least one
asset class within property, plant, and equipment and intangible assets.

Property, plant and equipment Investment property Intangibles

No. Industry name Sample With Fair Historical With Fair Historical With Fair Historical
PPE value cost inv. value cost intan. value cost
No. % No. % prop. No. % No. % No. % No. %
13 Aerospace 1 1 0 0% 1 100% 0 0 N/A 0 N/A 1 0 0% 1 100%
16 Apparel 11 11 0 0% 11 100% 0 0 N/A 0 N/A 11 0 0% 11 100%
19 Automotive 10 10 0 0% 10 100% 4 0 0% 4 100% 10 0 0% 10 100%
22 Beverages 9 9 0 0% 9 100% 3 1 33% 2 67% 9 0 0% 9 100%
25 Chemicals 16 16 0 0% 16 100% 2 0 0% 2 100% 16 0 0% 16 100%
28 Construction 22 22 0 0% 22 100% 8 1 13% 7 88% 22 0 0% 22 100%
31 Diversified 8 8 0 0% 8 100% 7 0 0% 7 100% 8 0 0% 8 100%
34 Drugs, Cosmetics, & Health care 25 25 0 0% 25 100% 4 0 0% 4 100% 25 0 0% 25 100%
37 Electrical 13 13 0 0% 13 100% 3 0 0% 3 100% 13 0 0% 13 100%
40 Electronics 78 78 0 0% 78 100% 6 1 17% 5 83% 77 0 0% 77 100%
43 Financial 96 96 3 3% 96 100% 57 28 49% 29 51% 87 0 0% 87 100%
46 Food 8 8 0 0% 8 100% 1 0 0% 1 100% 8 0 0% 8 100%
49 Machinery & equipment 54 54 1 2% 54 100% 11 2 18% 9 82% 54 0 0% 54 100%
52 Metal producers 1 1 0 0% 1 100% 0 0 N/A 0 N/A 1 0 0% 1 100%
55 Metal product manufacturers 6 6 1 17% 6 100% 1 0 0% 1 100% 6 0 0% 6 100%
58 Oil, gas, coal, & related services 5 5 0 0% 5 100% 1 0 0% 1 100% 4 0 0% 4 100%
61 Paper 6 6 0 0% 6 100% 1 0 0% 1 100% 6 0 0% 6 100%
64 Printing & publishing 6 6 0 0% 6 100% 3 0 0% 3 100% 6 0 0% 6 100%
67 Recreation 25 25 0 0% 25 100% 0 0 N/A 0 N/A 25 0 0% 25 100%
70 Retail 17 17 1 6% 17 100% 8 0 0% 8 100% 17 0 0% 17 100%
73 Textile 5 5 0 0% 5 100% 3 0 0% 3 100% 5 0 0% 5 100%
76 Tobacco 0 0 0 N/A 0 N/A 0 0 N/A 0 N/A 0 0 N/A 0 N/A
79 Transportation 7 7 0 0% 7 100% 3 0 0% 3 100% 7 0 0% 7 100%
82 Utilities 20 20 0 0% 20 100% 6 0 0% 6 100% 20 0 0% 20 100%
85 Other industries 156 156 1 1% 155 99% 19 1 5% 18 95% 154 0 0% 154 100%
Total Sample 605 605 7 1% 604 100% 151 34 23% 117 77% 592 0 0% 592 100%

40
Table 5: Asset classes and the application of fair value accounting
Table 5 presents evidence regarding which asset classes under property, plant, and equipment are recognized at fair value.
The No. columns present the number of companies that recognize assets at fair value within the respective asset classes.
The % columns present the values in the No. columns as a percentage of those companies in the UK, Germany, and the full
sample that use fair value for any class of assets under property, plant, and equipment.
1
Includes companies that use fair value under UK-GAAP or IFRS, or both.

United Kingdom Germany Full sample

1
No. % No. % No. %

Companies that use fair value for PPE 62 100% 7 100% 69 100%

Divided according to asset classes:

Property 58 94% 6 86% 64 93%

Plant 2 3% 0 0% 2 3%

Equipment 0 0% 0 0% 0 0%
PPE in general 2 3% 1 14% 3 4%

41
Table 6: Summary statistics for logistic regression analysis
Table 6, Panel A presents the summary statistics for our pooled (largest) sample. Panel B reports Pearson correlation
statistics. All variables are defined in Appendix C. Information regarding the use of fair value is hand-collected from
companies’ annual reports in Thompson One Banker. Other data is collected from the Worldscope database as of
December 2005.

Panel A: Summary Statistics

Variable Mean Std. Dev. Q25 Median Q75

Fair value dummy – PPE 0.035 0.184 0 0 0

Fair value dummy – Inv property 0.079 0.269 0 0 0
Inv property dummy 0.182 0.386 0 0 0
Germany 0.418 0.493 0.000 0.000 1.000
Sic65 0.093 0.290 0.000 0.000 0.000
Early 0.228 0.420 0.000 0.000 0.000
Size 11.781 2.150 10.207 11.668 13.251
PPEadj 0.238 0.243 0.034 0.159 0.358
Btm 0.573 0.507 0.289 0.491 0.783
MktLev 0.392 0.246 0.190 0.373 0.563
MktLevShort 0.293 0.210 0.140 0.245 0.416
MktLevLong 0.098 0.129 0.000 0.045 0.152
LevBook 0.561 0.456 0.360 0.561 0.718
LevBookShort 0.423 0.344 0.243 0.394 0.559
LevBookLong 0.137 0.221 0.001 0.071 0.209
DebtToOI 0.320 2.161 -0.485 0.707 1.590
Coverage 2.005 1.746 0.952 1.756 2.859
Current 0.501 0.803 0.073 0.381 0.820
Convertible 0.030 0.193 0.000 0.000 0.000
FairInvPr 0.079 0.269 0.000 0.000 0.000
DbtIss1 0.464 0.499 0.000 0.000 1.000
DbtIss2 0.272 0.445 0.000 0.000 1.000
FtrLev1 0.679 2.082 0.261 0.458 0.725
FtrLev2 0.306 1.380 0.002 0.117 0.313
DbtGrow1 0.336 0.903 -0.059 0.197 0.546
DbtGrow2 0.277 1.634 -0.280 0.126 0.718

42
Table 6 continued
Panel B: Correlation Table

Variable/Number 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
1. Fair PPE 1.00
2. Fair IP 0.06 1.00
3. IP 0.00 0.45 1.00
4. Germany -0.07 -0.13 0.17 1.00
5. Sic65 0.07 0.30 0.28 0.01 1.00
6. Early -0.01 -0.06 0.03 0.61 0.00 1.00
7. Size -0.10 -0.03 0.12 -0.19 0.02 -0.02 1.00
8. PPEadj 0.07 0.02 0.12 -0.08 0.08 -0.13 0.10 1.00
9. Btm 0.08 0.06 0.10 0.19 0.09 0.05 -0.39 0.14 1.00
10. MktLev 0.03 0.04 0.14 0.11 0.07 -0.05 -0.15 0.17 0.43 1.00
11. MktLevShort 0.04 0.05 0.12 0.14 -0.03 0.04 -0.19 -0.08 0.37 0.80 1.00
12. MktLevLong -0.01 0.00 0.08 -0.01 0.15 -0.13 0.02 0.39 0.20 0.54 -0.07 1.00
13. LevBook -0.01 0.01 0.06 -0.09 -0.02 -0.14 0.16 0.07 -0.23 0.68 0.51 0.41 1.00
14. LevBookShort 0.01 0.03 0.05 -0.01 -0.10 -0.01 0.05 -0.20 -0.18 0.46 0.77 -0.31 0.68 1.00
15. LevBookLong -0.03 -0.01 0.02 -0.12 0.09 -0.17 0.16 0.33 -0.09 0.34 -0.24 0.90 0.50 -0.29 1.00
16. DebtToOI -0.08 0.00 0.07 0.04 0.10 -0.06 0.01 0.26 0.19 0.51 0.13 0.67 0.41 -0.10 0.65 1.00
17. Coverage 0.03 0.00 -0.05 -0.12 -0.08 0.00 0.17 -0.21 -0.28 -0.62 -0.34 -0.55 -0.42 -0.07 -0.47 -0.76 1.00
18. Current -0.03 -0.07 -0.09 0.16 0.07 0.16 -0.09 -0.32 0.05 -0.39 -0.30 -0.22 -0.50 -0.38 -0.21 -0.25 0.30 1.00
19. Convertible -0.04 -0.03 0.01 0.10 -0.04 0.11 0.07 -0.04 -0.04 -0.05 -0.05 -0.02 -0.06 -0.06 -0.01 -0.06 0.01 0.04 1.00
20. FairInvPr 0.06 1.00 0.45 -0.13 0.30 -0.06 -0.03 0.02 0.06 0.04 0.05 0.00 0.01 0.03 -0.01 0.00 0.00 -0.07 -0.03

43
Table 7: Choice of fair value for investment property group
Table 7 presents the estimates from the logistic regression of the IFRS fair value indicator on a set of company-specific
variables. All variables are defined in Appendix C. Information on the use of fair value is hand-collected from companies’
annual reports in the Thompson One Banker. The data is taken from the Worldscope database as of December 2005. The
sample consists of 275 companies (124 UK companies; 151 German companies) that hold investment property. Requiring
non-missing values for explanatory variables further limits the sample in some specifications. ***, **, * indicate statistical
significance at less than 1%, 5%, and 10%, respectively.

Variables (1) (2) (3) (4) (5) (6)

UK (constant) 0.460* 1.24 1.37 3.084** 4.153*** 4.456**

[1.759] [0.949] [0.857] [2.011] [2.595] [2.120]
[0.079] [0.343] [0.391] [0.044] [0.009] [0.034]
UkSic65 2.215*** 2.115*** 2.792*** 1.873** 1.425** 2.090**
[3.818] [3.436] [3.231] [2.140] [1.996] [2.432]
[0.000] [0.001] [0.001] [0.032] [0.046] [0.015]
Germany –2.539*** –3.822*** –4.735*** –4.242*** –4.437*** –3.471***
[–6.142] [–6.133] [–4.808] [–5.374] [–5.707] [–3.743]
[0.000] [0.000] [0.000] [0.000] [0.000] [0.000]
GermanySic65 1.848*** 1.893*** 1.776** 1.672*** 1.632*** 0.298
[4.344] [3.586] [2.284] [2.714] [2.675] [0.302]
[0.000] [0.000] [0.022] [0.007] [0.007] [0.763]
Early 1.320** 1.866** 1.543*** 1.462** 1.151
[2.551] [2.174] [2.625] [2.486] [1.154]
[0.011] [0.030] [0.009] [0.013] [0.249]
Size –0.158* –0.214* –0.202* –0.204** –0.370**
[–1.680] [–1.789] [–1.914] [–1.991] [–2.210]
[0.093] [0.074] [0.056] [0.046] [0.027]
MktLev 2.681***
[3.400]
[0.001]
MktLevShort 3.381***
[3.020]
[0.003]
MktLevLong 4.090**
[1.966]
[0.049]
Convertible 3.841**
[2.366]
[0.018]
DebtToOi 0.337**
[2.197]
[0.028]
Coverage –0.380***
[–2.585]
[0.010]
Current –0.820*
[–1.789]
[0.074]

Observations 275 244 172 182 192 140

Pseudo R-squared 0.335 0.409 0.508 0.437 0.426 0.434

44
Table 8: Future financing and the use of fair value accounting
Table 8 presents the estimates from OLS regressions of future financing choices on the IFRS fair value indicator and a set
of company-specific controls. All variables are defined in Appendix C. Information on the use of fair value is hand-
collected from companies’ annual reports in the Thompson One Banker. All other data is taken from the Worldscope
database between December 2005 and 2007. The sample consists of 275 companies (124 UK companies; 151 German
companies) that hold investment property. Requiring non-missing values for explanatory variables further limits the sample
in some specifications. ***, **, * indicate statistical significance at less than 1%, 5%, and 10%, respectively.

(1) (2) (3) (4) (5) (6)

Variable DbdIss1 DbtIss2 FtrLev1 FtrLev2 DbtGrow1 DbtGrow2

Fair 0.181** 0.130* 0.665* 0.357* 0.444*** 0.445**

[2.084] [1.706] [1.729] [1.898] [2.724] [1.973]
[0.038] [0.089] [0.085] [0.059] [0.007] [0.050]
UK -0.0592 -0.105 -0.593 -0.245 -0.362** -0.322
[-0.714] [-1.437] [-1.552] [-1.358] [-2.256] [-1.450]
[0.476] [0.152] [0.122] [0.176] [0.025] [0.149]
Size 0.0399*** -0.00716 -0.0801 -0.0418 0.016 0.0222
[2.798] [-0.609] [-1.451] [-1.098] [0.677] [0.476]
[0.006] [0.543] [0.148] [0.273] [0.499] [0.635]
MktLev -0.133 -0.111 -0.155 0.0984 -0.985*** -1.179**
[-1.032] [-0.976] [-0.226] [0.220] [-3.586] [-2.424]
[0.303] [0.330] [0.821] [0.826] [0.000] [0.016]
Sic65 0.0905 0.209*** 0.115 0.351*** 0.03 0.155
[1.258] [3.159] [0.746] [3.234] [0.304] [0.758]
[0.210] [0.002] [0.457] [0.001] [0.761] [0.449]
Constant -0.0199 0.350** 1.936* 0.778 0.56 0.48
[-0.104] [2.233] [1.817] [1.161] [1.360] [0.815]
[0.434] [0.111] [0.115] [0.126] [0.024] [0.122]

Observations 244 244 230 229 230 197

R-squared 0.06 0.091 0.055 0.067 0.116 0.07

45
Table 9: Use of fair value for property, plant, and equipment
Table 9 presents the estimates from the logistic regression of the IFRS fair value indicator on a set of company specific
variables. All variables are defined in Appendix C. Information on the use of fair value is hand-collected from companies’
annual reports in the Thompson One Banker. The data is taken from the Worldscope database as of December 2005. The
results are based on a matched sample of companies that began using fair value after IFRS adoption. We match each fair
value company to historical cost companies on country, two-digit industry group, and the log of market value of equity and
take the closest match. This procedure, which requires non-missing market value of equity, yields 90 observations.
Requiring non-missing values for other explanatory variables further limits the sample. Standard errors are clustered at
industry level. ***, **, * indicate statistical significance at less than 1%, 5%, and 10%, respectively.

Variable (1) (2) (3) (4) (5)

Germany -2.130*** -2.109*** -1.885*** -1.920*** -1.987***

[9.857] [4.130] [3.809] [3.843] [3.754]
[0.000] [0.000] [0.000] [0.000] [0.000]
PPEA 1.483*** 2.180*** 1.099** 1.732*** 1.043*
[3.559] [2.934] [2.031] [2.719] [1.670]
[0.000372] [0.0034] [0.0423] [0.00654] [0.0950]
Btm 0.490** 0.428* 0.737*** 0.768*** 0.458*
[2.179] [1.819] [2.935] [3.064] [1.945]
[0.0293] [0.0689] [0.0033] [0.0021] [0.051]
MktLev 2.736*** 2.693***
[3.749] [3.000]
[0.0002] [0.0027]
MktLevShort 3.311***
[3.607]
[0.0003]
MktLevLong 1.293
[0.811]
[0.417]
Convertible -4.161 -8.615
[-1.187] [-0.647]
[0.235] [0.518]
LevBook 0.309**
[2.391]
[0.0168]
LevBookShort 1.285*
[1.952]
[0.0510]
LevBookLong -0.286
[-0.207]
[0.836]
FairInvPr 1.129**
[2.407]
[0.0161]
Industry dummies Yes Yes Yes Yes Yes
Observations 1,068 1,067 1,068 1,067 1,068
Pseudo R-squared 0.186 0.196 0.16 0.172 0.202

46
Table 1D: The effect of fair value accounting on asset values
Table 1D illustrates the differences in the book value of assets for fair value versus historical cost companies.
Information regarding the use of fair value is hand-collected from companies’ annual reports in Thompson One Banker.
The data is taken from the Worldscope database as of December 2005. Panel A presents a sample of 275 companies
(124 UK companies; 151 German companies) that hold investment property. Panel B is based on a matched sample of
companies that began using fair value after IFRS adoption. We match each fair value company with historical cost
companies on country, two-digit industry group, and the log of market value of equity, and take the closest match. This
procedure, which requires non-missing market value of equity, yields 90 observations. BTM is book value of equity
divided by the market value of equity, TA is total value of assets, MKT(TA) is market value of assets plus book value of
liabilities, ROA is return on assets, and PPE/MKT(EQUITY) is book value of property, plant, and equipment divided by
the market value of equity.

Statistics BTM TA/MKT(TA) ROA PPE/MKT(EQUITY)

Panel A: Investment property

Mean:
Historical cost mean 0.68 0.80 5.75
Fair value mean 0.87 0.93 4.98
Difference –0.18 –0.13 0.77
% –26.78 –16.11 13.46
t-stat –3.24 –4.20 0.56
p-value 0.001 0.000 0.574

Median:
Historical cost median 0.64 0.83 4.81
Fair value median 0.88 0.97 3.79
Difference –0.25 –0.14 1.02
% –38.55 –16.45 21.12
z-stat –3.74 –4.56 1.12
p-value 0.00 0.00 0.26
Panel B: Property, plant, and equipment

Mean:
Historical cost mean 0.50 0.71 7.47 0.40
Fair value mean 0.94 0.93 4.33 0.94
Difference –0.43 –0.22 3.14 –0.55
% –86.60 –31.20 42.00 –136.86
t-stat –4.40 –4.06 2.24 –2.81
p-value 0.00 0.00 0.14 0.01

Median:
Historical cost median 0.44 0.73 5.97 0.11
Fair value median 0.83 0.93 3.33 0.46
Difference –0.40 –0.20 2.64 –0.35
% –90.89 –26.65 44.22 –309.86
z-stat –3.91 –3.60 1.83 –3.12
p-value 0.00 0.00 0.07 0.00