Goodwill Impairment: A New Window For Earnings Management?

Abstract

The Financial Accounting Standards Board promulgated standard No. 142 in an attempt to improve the understandability of accounting information. This new rule eliminated the practice of automatically amortizing goodwill. No. 142 requires public companies to test goodwill for possible impairment at least annually. An unintended consequence of this new standard is the opportunity for companies to use it in earnings management. 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. 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. Thus, the results strongly suggest that companies are using No. 142 in an attempt to manage the volatility of earnings.