Determinants of goodwill impairments under IAS 36 : examination of Finnish listed companies
1University of Oulu, Oulu Business School, Department of Accounting, Accounting
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One of the most significant development in the International Financial Reporting Standards (IFRS) has been the increased use of fair values as the most commonly used asset valuation approach. According to standard setters, the use of fair value estimates in valuing assets provides users of financial information more timely, accurate and transparent information of the underlying economic condition of companies that apply IFRS standards in their financial statements. This in turn improves the decision usefulness of financial information reported in these financial statements. Nevertheless, valuing assets at their fair values can be a complex task which requires a number of managers’ assumptions and estimations for the valuation of assets that are not actively traded in markets. Further, assets that are valued at their fair values can be opportunistically overstated or understated when such managements’ unverifiable estimates are used in valuing assets. The issue with unverifiable estimates is especially problematic with goodwill, which is recognized in a business combination as the excess of the purchase price and the fair value of net assets received in the acquisition. The current IFRS standards require companies to carry out an annual impairment test for goodwill instead of straight-line amortization. According to the International Accounting Standard (IAS) 36 Impairment of Assets, companies that apply IFRS standards in their financial reporting must apply fair value estimates to determine goodwill impairments. That is, a company must record a goodwill impairment loss if the fair value of a cash-generating unit to which goodwill has been allocated is less than its carrying amount. The IAS 36 standard itself does not give specific guidelines on how the goodwill impairment test should be executed. Thus, the standard may provide managers incentives to opportunistically manipulate the outcomes of goodwill impairment tests in order to overstate or understate earnings. The purpose of the thesis is to examine the determinants of goodwill impairment losses in Finnish listed companies. The determinants examined in the thesis are divided into three categories: the economic or actual indications of goodwill impairments, managerial discretion and corporate governance mechanisms. Firstly, the thesis examines the actual economic occurrences that impact on goodwill impairment losses in Finnish listed companies. Secondly, the thesis studies the extent to which managers of Finnish listed companies utilize discretion in goodwill impairment decisions. Finally, the effect of corporate governance mechanisms on goodwill impairment losses is investigated to determine whether the managers of Finnish listed companies are opportunistically manipulating goodwill impairment tests or if indications of opportunistic behavior are in fact due to managers’ attempts to convey their private information on the underlying economic condition of the company. The findings of the thesis indicate that the leading economic factors affecting goodwill impairment losses are a company’s book-to-market ratio and the amount of goodwill to total assets. The results show that the higher a company’s book-to-market ratio the more likely the company is to report a goodwill impairment loss. Likewise, the higher the amount of goodwill is to total assets the more likely a company is to impair goodwill. These results are consistent with a number of prior research on the subject. Furthermore, as predicted, the results disclose that Finnish listed companies that have experienced a recent change in CEO are more likely to impair goodwill. Newly appointed CEOs may be more inclined to impair goodwill in order to blame the impairments on the previous CEO. On the other hand, new CEOs may impair goodwill as they try to help a troubled company by restructuring a company’s assets. Finally, the results show a significant relationship between big bath behavior and goodwill impairment losses: companies that have abnormally low earnings are more likely to report goodwill impairment losses during in order to report higher future earnings. However, the results show no significant relationship between goodwill impairment losses and corporate governance mechanisms. This could mean that the managers of Finnish listed companies may be to some extent manipulating the outcomes goodwill impairment tests. The results of the thesis should be of standard setter’s interest. In order to assess if IAS 36 serves its purpose to provide users of financial information more timely and decision usefulness information on the fair values of a company’s assets and value, the standard setters should evaluate the findings of studies on goodwill impairment losses and the determinants that explain them. Additionally, the results of the thesis can be used in order to identify the circumstances in which managers may have incentives to opportunistically manipulate outcomes of goodwill impairment tests.
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