Goodwill Impairment and Audit Effort

Abstract

SYNOPSIS Using abnormal audit fees to capture added charges associated with incremental audit effort beyond the effort level needed under normal circumstances, we find that the incremental audit effort is positively associated with goodwill to total assets. Additionally, when goodwill is impaired, auditors exert incrementally more effort for testing the magnitude of a goodwill impairment loss than when goodwill is not impaired. Further, we document predictable temporal and cross-sectional variations in audit effort and goodwill relationship. As the accounting standards became more (less) stringent, there is a corresponding increase (decrease) in audit effort. The effort also varies cross sectionally with auditor quality. We also find that only a goodwill impairment loss is associated with longer audit delays. Finally, we provide corroborating evidence based on survey responses obtained from expert auditors. Our results contradict the perception that auditors do not exert incrementally more effort when testing goodwill for impairment. JEL Classifications: M40; M42; C42.