Goodwill Impairment: A New Window For Earnings Management?

Abstract

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt; mso-pagination: none; mso-layout-grid-align: none;"><span style="font-size: 10pt; mso-bidi-font-weight: bold; mso-bidi-font-style: italic;"><span style="font-family: Times New Roman;">The Financial Accounting Standards Board promulgated standard No. 142 in an attempt to improve the understandability of accounting information. <span style="mso-spacerun: yes;"> </span>This new rule eliminated the practice of automatically amortizing goodwill. <span style="mso-spacerun: yes;"> </span>No. 142 requires public companies to test goodwill for possible impairment at least annually. <span style="mso-spacerun: yes;"> </span>An unintended consequence of this new standard is the opportunity for companies to use it in earnings management.<span style="mso-spacerun: yes;">  </span>To test the possibility that the rule is being used for this purpose, a sample of companies was chosen, all of which had amounts of goodwill on their balance sheet during the 2003-2005 interval. <span style="mso-spacerun: yes;"> </span>The results reveal that the number of companies experiencing losses or low rates of return on total assets who actually impaired goodwill was statistically insignificant during the period under consideration.<span style="mso-spacerun: yes;">  </span>Thus, the results strongly suggest that companies are using No. 142 in an attempt to manage the volatility of earnings.<span style="mso-spacerun: yes;">   </span></span></span></p>