The Effect of Audit Quality and Audit Committees on Goodwill Impairment Losses

Abstract

Using a sample of 528 firm-year observations, drawn from the top 500 U.K. listed firms, this study examines the effect of audit quality and audit committee (hereafter: AC) characteristics on goodwill impairment losses recorded following the mandatory adoption of IFRS 3 “Business Combinations”. The hypothesis investigated is that managers disciplined by effective ACs and auditors are less likely to act opportunistically but instead use their accounting discretion to convey their private information resulting in the recognition of higher amounts of existing goodwill impairments that better reflect the underlying performance of the firm. Shareholders will not expect ACs and auditors to constrain accounting choices (e.g., goodwill impairments) used credibly by managers. After controlling for economic factors and financial reporting incentives, empirical results reveal that auditor and AC characteristics do not seem to have a significant effect on the recognition of goodwill impairments. Although ACs are expected to act as a monitoring device, the monitoring incentives of AC directors may be hampered by the joint board responsibility for the quality of financial reporting. The results also suggest that the formation of ACs does not always necessarily imply effective monitoring as ACs may fall short of doing what are generally perceived as their duties (Sommer, 1991). These results may be of interest to standard setters, regulators and policy makers.