Firms' Behavior Regarding Impairment of Goodwill Earnings Management & Big Bath Accounting

Abstract

Background and Discussion: In 2005 IASB issued new standards, IFRS, which became mandatory for all listed companies in the EU. From then on no amortizations of goodwill were allowed but yearly impairment tests had to be made. Since goodwill is an asset that allows judgment, its credibility has been discussed because of the uncertainty in the assessment process. There is a risk that managers use this judgment to manipulate their earnings. Methodology: Both a quantitative and a qualitative study has been performed to support this thesis. All annual reports on NASDAQ OMX Nordic through the years of 2008 to 2011 have been analyzed through statistical tests. Three interviews with accountants have also been conducted to gain a deeper knowledge. Analysis and Conclusion: The results of this thesis show signs that earnings management through the use of goodwill impairments does exist on NASDAQ OMX Nordic. The firms that made impairments have lower results in general than the non-impairment group. Among the firms that have made impairments there are indications that the observations with significant impairments have even more depressed earnings, and therefore have greater incentives to reduce the earnings even more according to the theory about big bath accounting. There seems to be a correlation between firm size and the propensity to manage earnings. Small firms are more likely to manage earnings according to our study and it is harder to conclude that earnings management exists on Mid and Large Cap due to a low number of significant observations. Even though the conducted research suggests that earnings management exists due to large impairments in times of trouble, it is really hard to determine what the true reasons behind the impairment are. According to the interviewees it is more an act of overconfidence rather than purposely managing the earnings.