Accounts for acquired goodwill has been a subject to debate considerably for several decades. K-IFRS has been changed an approach to goodwill accounting by abolishing goodwill amortization and requiring goodwill be tested for impairment using estimates of its current fair value. K-IFRS has expected that the standard will improve financial reporting because a new approach to goodwill will better reflect the underlying economics of a firm’s assets.
Despite the standard setter’s claim, it is possible that the change of goodwill accounting may lead it to worse financial reporting. Estimates of the current fair value of goodwill solely rely on assumption about management’s future actions, including conceptualization and implementation of firm strategy. As such, it is difficult to verify and audit.
This study is motivated to investigate whether a new goodwill accounting improves the quality of financial statement or not. In particular, an accounting choice about goodwill impairment is classified into two groups based on the existence of market impairment indication and recognition of goodwill impairment. If a firm’s decision to impairment is consistent with market indication of impairment, it is identified as a normal accounting choice. On the other hand, a firm’s decision which is not consitent with market indication of impairment is classified as discretional accounting choice about goodwill impairment. Then, firms with discretional accounting choice is sorted that there is market impairment indication but no impairment on accounting book, postponing firm, or there is no market impairment indication but recognized impairment, accelerating firm. If a manager’s discretional accounting choice conveys his(or her) private information about the firm’s future cash flows, the new goodwill accounting diminishes information asymmetry and improves the quality of financial statement. If a manager exploits the unverifiable feature in goodwill accounting rules to manage financial reports opportunistically in line with his or her own private incentive, the quality of financial statement is worse. The test samples in this paper are drawn from a set of 592 firm-year observation spanning from 2011-2013. Main findings can be summarized as follows. First, the consistent evidence with the prediction of agency theory that mangers use new goodwill accounting as a way of opportunistic disclosures was found, and it deteriorates the value relevance of accounting numbers. In contrast, no support for prediction is found which explains discretionary accounting choices related to the existence of flexibility or with managers’ possessing positive private information about the firm. Second, in the firm with accelerated impairment, one of the firms that choose discretionary accounting choice, the goodwill impairment is likely to be associated with “big-bath” accounting behaviors. Third, other discretionary accounting firms that postpone goodwill impairment in their accounting books manage their current level of cash flows upward compared to other normal groups. This result is consistent with a robust test with another strategy to identify the firms with discretionary accounting choices.
This study contributes to the existing goodwill impairment literature on several levels. First, to my knowledge, this is the first study to consider the firms with non-impairment in Korea. While the prior studies only concentrated on the firms which recognize goodwill impairment on their financial statement, the samples in this paper includes the firms with non-impairment. In addition, recent innovations in classified firms are also incorporated and the results suggest that managers exploit the discretion, by new accounting treatment under K-IFRS to manage earnings. Nevertheless, this study is limited by the ability to identify the firms which are in discord with market impairment index.