Goodwill Impairment Losses Research Articles

Does Goodwill-Related Critical Audit Matters Disclosure Influence Firms’ Financial Reporting Decisions? Evidence from Goodwill Impairment

SUMMARY We investigate whether the new critical audit matters (CAMs) disclosure requirement for auditors under the PCAOB Standard AS 3101 affects audited firms’ financial reporting decisions in the context of goodwill impairment recognition. We argue that an auditor's intense engagement with management and the audit committee in the CAMs determination and evaluation process improves management's information sets. Specifically, we report that the propensity to recognize goodwill impairment loss increases for firms with goodwill-related CAM disclosure relative to those without. This result is more pronounced when the likelihood of expected impairment is higher, suggesting that CAMs reporting lowers managers’ discretion in delaying impairment loss recognition. Additionally, we find that goodwill-related CAM disclosure increases the length and use of uncertain words in goodwill-related footnote disclosure by management but has no significant impact on audit costs. Overall, these findings suggest that adopting CAMs requirements can reduce management's discretion in financial reporting decisions. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; M42.

Goodwill Impairment Losses and Audit Fees

This paper examines whether goodwill accounting is related to auditor compensation. Specifically, it investigates whether goodwill impairment losses reported by auditees are associated with audit fees they have to pay their auditors. I predict a positive link between the amount of goodwill impairments reported by client firms and audit fees that auditors charge them. Goodwill impairment charges are likely to diminish financial reporting quality because they are susceptible to managerial opportunism and, thus, auditors are likely to consider them posing higher audit risk. Responding to higher risk of material misstatements in the financial statements of auditees, auditors are likely to increase audit effort as well as audit fees. Consistent with the prediction, the results show that goodwill impairment losses are positively associated with audit fees.

The information content of half-yearly goodwill impairment losses: analysis of the European context

PurposeThis study aims to contribute to the debate on goodwill accounting by examining the information content of impairment losses recognized in half-yearly reports. Half-yearly reports provide a suitable context to examine the effectiveness of the impairment process. Due to IFRIC 10 requirements, indeed, managers may have incentives to avoid recognizing impairment losses at the interim reporting date.Design/methodology/approachThe study adopts an archival approach. Based on the traditional Ohlson’s model (1995), it explores the information content of half-yearly impairment losses in the European context over the period 2007–2017.FindingsFindings confirm the relevance of half-yearly reports and suggest that half-yearly impairment losses are significantly associated with stock prices. In particular, investors positively value companies that recognized goodwill impairment losses at the interim reporting date.Research limitations/implicationsThe study contributes to the academic debate on goodwill and the effectiveness of the impairment procedure. In particular, it provides empirical evidence on the recognition of goodwill write-offs when it is possible to avoid the impairment test in the absence of indications of impairment.Practical implicationsFindings of this study can support the current debate on accounting for goodwill also in the light of the recent proposals of the IASB on the need to improve the effectiveness of the impairment test.Originality/valueThis study provides original empirical evidence on the goodwill impairment test in half-yearly reports, extending previous research that typically examines this issue in annual reports.

The Effect of Time Orientation in Languages on the Recognition of Goodwill Impairment Losses

Synopsis The research problem In this study, we investigated the relationship between future-time reference (FTR) in languages and goodwill impairment. Motivation Previous studies on goodwill have focused mainly on firms’ economic and reporting incentives in single-country settings using economic theories. There have been recent calls for more research on goodwill accounting across countries (d’Arcy and Tarca, 2018), and greater use of behavioral theories in goodwill accounting studies (Amel-Zadeh et al., 2021). In response, we applied the linguistic relativity hypothesis to a new and highly significant area of future-oriented behavior (impairment decision) to explain cross-country variations in goodwill impairment reporting. The test hypotheses We hypothesized that firms in countries that use weak-FTR languages have higher levels of (and greater quality) goodwill impairment than those in countries that use strong-FTR languages. Target population We used a sample of 15,179 firm-year observations taken from firms reporting under IFRS across 21 countries for the fiscal years 2005–2018. Adopted methodology We used Tobit regressions, logit regressions, mixed-effects modeling, and propensity score-matching analyses for robustness. Analyses We tested the relationship between FTR in languages and (a) goodwill impairment decisions, (b) goodwill impairment amounts, and (c) abnormal goodwill impairments. We repeated our main analyses using several subsamples, different measures of FTR, and alternative regression specifications. Findings In line with the linguistic relativity hypothesis, our findings indicate that managers who speak weak-FTR languages are more willing to bear the costs of their impairment decisions in the present and are less motivated to shift current impairment into future accounting periods. In contrast, speakers of strong-FTR languages tend to delay the recognition of current impairments to future periods to reduce their anxiety about the negative effects of current impairment decisions. Findings from further analyses indicate that firms in weak-FTR countries report lower abnormal goodwill impairment, thereby bringing impairment levels closer to their normal optimal levels. Our inferences are robust to alternative samples, different measures of FTR, and alternative model specifications.

M&A compensation commitment and stock price crash risk: evidence from China

ABSTRACT This paper examines the effect of M&A compensation commitment on stock price crash risk using the setting of Chinese M&As that committed performance has been achieved during the commitment period. We observe an increase in stock price crash risk after the expiration of M&A compensation commitment, and the effect is more significant in companies whose committed performance precise completion. Further analyses show that the ex post stock price crash risk is more strengthened in companies with higher agency conflicts and SOEs, but the external governance roles, Big-4 auditors and analysts, can weaken this effect. The channel analysis shows that the bad news is that goodwill impairment loss after the expiration of the commitment period is released, leading to an increasing stock price crash risk. Overall, our finding shows that M&A compensation commitment has an ex post effect on stock price crash risk.

Labor unions and post‐acquisition integration capability: Evidence from goodwill impairment

AbstractWe examine whether operating inflexibility posed by labor unions affects goodwill impairment. We predict such inflexibility hinders resource reallocation after acquisition, thereby preventing the acquiring firm from realizing synergies included in goodwill. Consistent with this prediction, we find that the strength of labor unions is positively associated with the likelihood and magnitude of goodwill impairment losses. Our results are robust to a battery of tests that address the potential endogeneity. Furthermore, we find that managers who possess superior ability mitigate the negative consequences of labor unions on goodwill impairment. Overall, our findings suggest that operating inflexibility posed by labor unions is an important determinant of goodwill impairment that indicates a failure to realize the expected synergy from the acquisition.

The Role of the Board in Unrelated Diversifications: Evidence from an Acquisition Wave in China

Unrelated diversifications are generally more viable in underdeveloped institutional environments because internal markets within the diversified firm can substitute the inefficient external ones. Using a sample of 498 major acquisitions undertaken during an acquisition wave by Chinese listed firms, we find acquiring a target firm in an entirely different industry can cause more severe goodwill impairment losses in the following two to four years, which indicates that acquirer managers tend to overestimate the synergistic gains they could realize in unrelated diversifications. Moreover, a capable board of directors can provide information advantages through outside directorship ties, structural hole position in the interlock network, and specialized committees, thus limit managers to make value-destroying diversification decisions. Further analysis suggests investors tend to prefer such unrelated acquisitions during the acquisition wave, indicating that shareholder expectations drive managers to diversify. By examining the role of boards as information conduits and advice-providers in limiting the cost of diversification in an underdeveloped institutional environment, this study contributes to the literature on diversification, acquisition and corporate governance.

Association between corporate social responsibility and goodwill impairment: evidence from the European Union

I examine the association between corporate social responsibility (CSR) and goodwill impairment (GWI) in the European Union. A stream of literature indicates that CSR is associated with determinants of GWI. Prior literature has shown that each CSR component could generate individual effects. Therefore, I focus on disaggregating CSR into its main categories: environmental, social, and governance (ESG). I believe it is beneficial to provide evidence on the individual effects of ESG on GWI, as CSR affects multiple mergers and acquisitions (M&A) processes as well as the post-merger deal performance. Governance activities are in short-term associated with GWI, while social activities reveal a longer-term association (until t + 3). Furthermore, I investigate the association between ESG and the discretionary (unexpected) GWI losses. The results show that managers who engage in governance and environmental activities seem to act more ethically regarding earnings management behaviour.

Goodwill Impairment and Audit Effort

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.

Country-specific drivers of the value relevance of goodwill impairment losses

This study is the first to analyze the value relevance of goodwill impairment losses (GIL) in an international context; therefore, it builds a link between institutional, cultural, and religious factors and cross-country variations in the relevance of GIL. Using a sample of 18,143 firm-year observations drawn from 21 countries during the period 2005–2018, we find that firms, on average, reported GIL that are value relevant to their investors. However, consistent with the litigation perspective, the value relevance of GIL is found to be substantially higher for firms domiciled in countries with high-level institutional quality (IQ) than for firms in countries where IQ is relatively low. Our findings remain robust after controlling for macroeconomic effects or excluding observations from the biggest countries, which constitute a substantial proportion of the data set we analyzed. Additional tests show that institutional effects, although absorbing religion, did not supersede or restrain cultural effects, suggesting that social norms also influence the relevance of impairment information. Our evidence introduces a new explanation for heterogeneity in value relevance of goodwill impairments, and adds to research on the effects of legal and social norms on value relevance.

Goodwill impairment and CEO overconfidence

We examine how CEO overconfidence affects goodwill impairments after the adoption of SFAS 142 in US firms. Consistent with the nature of the cognitive position of overconfident CEOs, we find that both the likelihood and the magnitude of goodwill impairment recognition decrease when CEO overconfidence is elevated, providing evidence that SFAS142 is not applied consistently across firms. Overconfident CEOs are reluctant to book goodwill impairment losses. The results are robust with various model specifications, proxies for CEO overconfidence, and subsamples, suggesting that biased and less transparent financial reporting on goodwill impairment in firms with overconfident CEOs is an unintended consequence of SFAS142.

Do Economic Performance Indicators Support Firms’ Claiming a Goodwill Impairment Loss During a Prosperous Year?

Results from the academic literature stream support both the informative and uninformative aspects of goodwill accounting. However, gaps exist in the literature stream pertaining to the timing and managerial motivation for claiming goodwill impairment losses. Our study fills a gap in the literature by examining firms’ goodwill impairment loss write-offs during the year of 2006, a period of economic prosperity. We examine the association of firms’ goodwill impairment losses with both economic performance and accounting indicator variables. Our findings do not support the informative role of goodwill accounting. Further, goodwill impairment losses provide a marginal increase in the explanatory power of operating earnings as a predictor of the following period’s operating cash flows.

Cognitive Dissonance or Agency Theory, what Explains the Loss of Impairment of Goodwill?

Objective: The purpose of this research is to analyze the impairment loss of goodwill in companies listed in Brasil, Bolsa, Balcão [B]3 from the perspective of Agency Theory and Cognitive Dissonance Theory.Method: We used a sample composed of Brazilian non-financial publicly traded companies listed in [B]3. The analysis was conducted through the logistic regression, considering an unbalanced panel data set for the period from 2010 to 2016.Originality/Relevance: This study uses a theory of psychology, the Cognitive Dissonance Theory, to try to explain the occurrence of goodwill impairment loss.Results: The results point to the Cognitive Dissonance Theory as the theory that explains the goodwill impairment loss, since managers tend to record a goodwill impairment loss in the current year, when there was already a loss recorded in the previous year, as a way to decrease the mental discomfort caused between their cognitions.Theoretical/Methodological contributions: It contributes to the literature in order to associate the decisions made by managers with a psychological behavioral theory that until now has not received prominence in the attempts to justify the decisions of agents. The gain from this research is also directed to investors, as it allows them to make decisions not only based on what the accounting reports say, but taking into account other aspects, such as managers’ behavior and cognitions.

Dissonância Cognitiva ou Teoria da Agência, o que Explica a Perda por Impairment do Goodwill?

Objective: The purpose of this research is to analyze the impairment loss of goodwill in companies listed in Brasil, Bolsa, Balcao [B]3 from the perspective of Agency Theory and Cognitive Dissonance Theory.Method: We used a sample composed of Brazilian non-financial publicly traded companies listed in [B]3. The analysis was conducted through the logistic regression, considering an unbalanced panel data set for the period from 2010 to 2016.Originality/Relevance: This study uses a theory of psychology, the Cognitive Dissonance Theory, to try to explain the occurrence of goodwill impairment loss.Results: The results point to the Cognitive Dissonance Theory as the theory that explains the goodwill impairment loss, since managers tend to record a goodwill impairment loss in the current year, when there was already a loss recorded in the previous year, as a way to decrease the mental discomfort caused between their cognitions.Theoretical/Methodological contributions: It contributes to the literature in order to associate the decisions made by managers with a psychological behavioral theory that until now has not received prominence in the attempts to justify the decisions of agents. The gain from this research is also directed to investors, as it allows them to make decisions not only based on what the accounting reports say, but taking into account other aspects, such as managers’ behavior and cognitions.

Does managerial discretion affect the value relevance of goodwill impairment information under IFRS? Korean evidence

ABSTRACTThis study examines managers’ use of discretion in determining goodwill impairment losses and the differential value relevance of impairment information depending on the type of management discretion under IFRS in Korea. We distinguish management discretions into accelerated, timely, and delayed recognition of goodwill impairment. We find that impairment decision is driven by managerial incentives, such as big bath behaviour, income smoothing, and avoidance of loss reporting. Moreover, the impairment loss is positively (negatively) associated with contemporaneous share price and future expected cash flows, when managers recognize impairments in an accelerated (timely) manner. The positive association of accelerated impairment coincides with the negative value relevance of pre-impairment goodwill balance. We also observe that the accelerated impairers exhibit superior market performance in the 2-years subsequent to the reporting of goodwill-related information. Overall, the evidence documented in this study is in line with the positive valuation implication of accelerated discretionary impairment, consistent with a signalling perspective.

Discretionary goodwill impairment losses in Europe

Purpose The impairment-only approach to goodwill has regularly been criticized for offering too much discretion to managers and facilitating the manipulation of goodwill impairment losses. Extant research provides mixed results on whether managers exploit their inherent discretion informatively or opportunistically. The purpose of this paper is to examine the determinants of discretionary goodwill impairment losses in Europe. Design/methodology/approach The authors divide goodwill impairment losses into economically induced and discretionary parts. Thereafter, the authors examine the determinants of discretionary goodwill impairments. Findings The results indicate that discretionary goodwill impairment losses are used opportunistically rather than informatively. The authors find that managers exploit their discretion to “clear the deck” and to meet or beat analysts’ forecasts. However, the opportunistic behavior is constrained by corporate governance and enforcement mechanisms. Research limitations/implications The findings contribute to the current discussion on the suitability of the impairment-only approach by introducing inferences on how areas of discretion inherent in goodwill impairment testing are associated with management incentives and governance mechanisms in a European setting. Practical implications The results offer enforcers and standard-setters important insights into how mangers exploit discretion in goodwill accounting. These insights can help to identify firms that are likely to infringe upon the applicable accounting standards. Originality/value In contrast to prior research, the authors analyze the association among management incentives, governance mechanisms and discretionary goodwill impairment losses rather than the association with total or expected goodwill impairment losses. Moreover, to the best of authors’ knowledge, there is little empirical evidence based on a European (IAS 36) setting.

Is a Reported Goodwill Impairment Loss Really a Goodwill Impairment Loss? A Financial Reporting Case on Evaluating the Efficacy of Authoritative Guidance

ABSTRACT While undergraduate financial reporting courses focus primarily on the application of generally accepted accounting principles and the mechanics of accounting treatments, graduate-level courses should motivate students to explore standard-setting's theoretical perspective and to develop a more rigorous understanding of accounting issues not necessarily discussed in textbooks, but included, implicitly or explicitly, in the authoritative guidance. Anecdotal evidence suggests that accounting students face difficulties transitioning from the undergraduate setting to the higher expectations common in graduate accounting programs and the workplace. This hypothetical case provides an interesting scenario on goodwill impairment to facilitate the development of students' understanding of accounting theory and its connection to professional research skills. While students are accustomed to computing goodwill impairment losses from knowledge acquired in undergraduate financial accounting courses, this topic contains interesting theoretical and practical issues and serves as a salient example of the analysis of interesting accounting issues possible at the graduate level.

Is a Reported Goodwill Impairment Loss Really a Goodwill Impairment Loss? A Financial Reporting Case on Evaluating the Efficacy of Authoritative Guidance

Is a Reported Goodwill Impairment Loss Really a Goodwill Impairment Loss? A Financial Reporting Case on Evaluating the Efficacy of Authoritative Guidance

Do Economic Performance Indicators Support Firms' Claiming a Goodwill Impairment Loss During a Prosperous Year?

Do Economic Performance Indicators Support Firms' Claiming a Goodwill Impairment Loss During a Prosperous Year?

Increasing Auditor Recognition of Goodwill Impairment Losses

Auditing standards require auditors to evaluate the reasonableness of reported fair value estimates, but audit regulators frequently cite auditors for deficiencies in these estimates. Specific to goodwill, auditors must evaluate the probability that recorded goodwill is impaired. Based on small sample frames and availability theories, we predict that experiencing a recorded impairment at an unrelated client increases auditors’ internal perceived probability of downside risk. As a result, we expect more impairments at subsequent clients with economic indicators of impairment. Using a sample of 7,500 client-years from 2004-2014 with potential goodwill impairments, we find evidence consistent with our expectation at the audit office level. We also find evidence at the metropolitan statistical area and non-Big 4 audit firm levels; however, consistent with our expectation that the closer the auditor is to the prior impairment the stronger the effect, the audit office level effect is stronger than the other two levels and is especially strong in audit offices below the median size. Our study suggests that enhancing knowledge sharing around experienced goodwill impairments could help improve auditor difficulties in auditing uncertain fair value estimates and increase recognition of goodwill impairments.