The impairment test of goodwill: an empirical analysis of incentives for earnings management in Italian publicly traded companies

Abstract

Since the current International Accounting Standard 36 introduced substantial subjectivity while testing goodwill for impairment, this study aims to establish if management exploits the discretion and performs the impairment test of goodwill opportunistically. The presence of discretion, while applying impairment test, is tested on the sample of Italian publicly traded companies in the period of the current financial crisis. Despite the fact that the sample of companies consists of those with market to book ratio less than one, only 26% of the companies recorded a goodwill write-off. The logistic regression was used to test contracting and reporting incentives. The results of the analysis indicate that even in the case of IFRS users some incentives exist, while recognising the impairment losses of goodwill.

Keywords:

• Goodwill
• impairment testing
• earnings management
• IFRS
• financial crisis

Jel Classifications:

• M40
• M41
• M42

Notes

1. In the first year of FAS 142 introduction goodwill impairment losses were treated as below the line expenses, while in IFRS write-offs were charged to opening retained earnings.

2. Lai, Leoni & Stacchezzini (2010) made this kind of analysis on the sample of Italian insurance companies including data from 2005 to 2009. Since our sample does not include financial companies, results of their empirical analysis are not presented in details.

3. Data about the own shares repurchase, directors’ purchases of shares, changes of management, management remuneration and number of CGUs were hand collected from the annual reports.

4. We were not able to reduce the number of variables to the required level with the use of statistical tools as factor analysis, the exclusion of highly correlated variables and the exclusion of variables with missing data.

5. The impairment losses in the period of adoption were treated differently from subsequent periods. In the case of IAS 36 implementation the retroactive method was in use. Adoption write-offs were charged to opening retained earnings (no effect on income). Afterwards, impairment losses became a part of expenses from continuing operation.