Earnings management through goodwill impairment: empirical analysis of Finnish listed companies in 2005-2017
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School of Business |
Master's thesis
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Date
2018
Department
Major/Subject
Mcode
Degree programme
Accounting
Language
en
Pages
76 + 5
Series
Abstract
The IAS 36 standard has provided flexible guidelines for goodwill accounting under IFRS. As a result of the discretion provided in the annual goodwill impairment test, the goodwill impairment losses reported by companies are subject to management's subjective estimates. This enables management to adjust the impairments to the preferred magnitude, and postpone them if wished. In this study, an empirical analysis is carried out to examine the association of earnings management motives and goodwill impairment losses in Finnish listed companies between 2005 and 2017. Earnings management is examined by focusing on the patterns of big bath accounting, income smoothing, and covenant contract compliance. The study applies logistic regression to model the decision to report a goodwill impairment loss, and OLS regression to explore the magnitude of goodwill impairment losses. The results indicate that impairment losses are larger when earnings have experienced heavier declines, and that impairment losses are smaller for companies with higher levels of debt. The findings support the theories of big bath accounting and impairment avoidance under higher debt. Companies with high debt are assumed to reduce impairments to avoid violation of debt covenants. However, the evidence also indicates that there is no association of goodwill impairment decisions and earnings management patterns. In addition, income smoothing motives are not found to affect impairment size. The results suggest that some level of earnings management occurs in Finnish listed companies when determining the size of goodwill impairment losses, but not when deciding whether to impair goodwill. At the same time, some economic impairment factors, especially goodwill balance and book-to-market ratio, explain the impairment decision and size better than the earnings management motives.Description
Thesis advisor
Myllymäki, Emma-RiikkaKeywords
goodwill, impairment testing, earnings management, IAS 36, big bath, income smoothing