Does the Financial Reporting for Income Tax Expense Affect Financial Reporting Quality? Evidence from the Timeliness of Goodwill Impairments

Abstract

This study examines if financial reporting for income tax expense affects the timeliness of goodwill impairments. Goodwill impairments are an important signal of expected future cash flows, yet their timing is subject to managers’ discretion. U.S. GAAP requires firms to test all goodwill for impairment, whereas tax laws generally do not permit impairment deductions but require amortization for only some goodwill. Only when an impairment includes tax-amortizable goodwill will financial statement tax benefits partially offset the impairment’s negative effect on GAAP net income. Holding the size of pre-tax impaired goodwill constant and controlling for attributes of firms’ prior acquisitions, we predict and find that managers are more likely to delay impairments when the offsetting financial statement tax benefits are smaller. We estimate goodwill impairments are 15 to 20 percent more likely to be delayed when impairments generate reduced financial reporting tax benefits. Our findings suggest financial reporting for taxes potentially distorts the timeliness of goodwill impairments, informing the current debate on goodwill accounting.