Abstract
This study investigates whether goodwill impairments are influenced by earnings management incentives. It is motivated by the International Accounting Standards Board’s (IASB) post-implementation review on business combinations, the ongoing debate on the reliability of impairment testing, and the high practical relevance of this topic. The sample consists of 2,127 firm-year observations from German listed firms for the periods 2006 to 2013. The results show that the likelihood to recognize goodwill impairments and the magnitude of impairment losses are not only determined by economic and other relevant factors but also influenced by earnings management incentives like beating an earnings target, conservative smoothing, big bath accounting, changes in senior management, and the firms’ general earnings management behavior. Hence, goodwill impairment tests seem to be used by management as a device for earnings management. The results do not change over time, i.e., between the period before, during, and after the financial crisis.
Highlights
On March 31, 2004, the revised IAS 36 became effective replacing the long-accepted straight-line amortization of goodwill by a new impairment-only approach
We focus on the question of whether earnings management incentives relate to the likelihood to recognize goodwill impairments and the magnitude of impairment losses
We focus on the two positions on the management board with arguably the highest influence on financial reporting decisions, such as goodwill impairments, chief executive officer (CEO) and chief financial officer (CFO) (Jiang, Petroni, & Wang, 2010), and test the following hypothesis: H4: Firms whose CEO or CFO is newly appointed to the management board are more likely to recognize goodwill impairments and report larger impairment losses
Summary
On March 31, 2004, the revised IAS 36 became effective replacing the long-accepted straight-line amortization of goodwill by a new impairment-only approach. With respect to debt financing, we find a positive association between leverage and the likelihood (magnitude) of impairment (losses) This is inconsistent with prior US literature, which suggests that firms manage goodwill impairments to avoid costly debt covenant violations. Some of the inconsistency in prior literature might be explained by statistical tests with low power, because most data sets only cover a short time period and, the number of observations is small (e.g., AbuGhazaleh, Al-Hares, & Roberts, 2011; Iatridis & Senftlechner, 2014; Avallone & Quagli, 2015; Giner & Pardo, 2015; Hassine & Jilani, 2017) We address this issue by providing evidence based on a larger data set.
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