Academic journal article Canadian Journal of Administrative Sciences

Equity Recognition of Mandatory Accounting Changes: The Case of Transitional Goodwill Impairment Losses

Academic journal article Canadian Journal of Administrative Sciences

Equity Recognition of Mandatory Accounting Changes: The Case of Transitional Goodwill Impairment Losses

Article excerpt

Abstract

This study investigates if and how the use of the retroactive method to account for a mandatory accounting change affects a firm's measurement and recognition choices. We examine if reporting incentives and constraints are associated with the magnitude of transitional goodwill impairment losses reported by Canadian firms implementing Section 3062 on purchased goodwill. Our results indicate firms have an incentive to both overstate and understate transitional goodwill impairment losses. We also show that financially literate and independent audit committees constrain managerial opportunism.

Copyright © 2008 ASAC. Published by John Wiley & Sons, Ltd.

JEL Classification: M41

Keywords: accounting for goodwill, goodwill impairment, audit committee, corporate governance, mandatory accounting changes

Résumé

Cette étude examine dans quelle mesure et de quelle manière l'usage de la méthode rétroactive pour rendre compte d'un changement obligatoire de convention comptable influence les choix d'évaluation et de constatation d'une firme. Elle cherche à savoir si les incitatifs et contraintes sont associés à l'ampleur des réductions de valeur transitoires de l'écart d'acquisition constatées par les entreprises canadiennes suivant l'adoption du chapitre 3062 sur les écarts d'acquisition. Nos résultats indiquent que les entreprises ont des incitatifs tant pour minimiser que pour maximiser les réductions de valeur transitoires de l'écart d'acquisition. Nous démontrons également que des comités de vérification indépendants et compétents peuvent limiter l'opportunisme managerial Copyright © 2008 ASAC. Published by John Wiley & Sons, Ltd.

Mots-clés : comptabilisation de l'écart d'acquisition, réduction de valeur de l'écart d'acquisition, comité de vérification, gouvernance d'entreprise, changements de convention comptable obligatoires

This paper investigates if and how reporting incentives and constraints influence firms' adoption choices when firms are required to use the retroactive method to account for a mandatory accounting change. More specifically, we examine the reporting incentives and constraints associated with the magnitude of transitional goodwill impairment losses reported by Canadian firms following the adoption of revised standards on purchased goodwill. Since 2002, through a standard jointly developed and implemented (SFAS 142 in the United States; section 3062 of the Canadian Institute of Chartered Accountants' Handbook in Canada), American and Canadian firms must (a) stop goodwill amortization and (b) conduct a two-step impairment test on goodwill on the same date every year. The standard also requires firms to recognize existing unrecognized impairment losses as a cumulative effect of a change in accounting principle. The Canadian context provides a unique opportunity to assess whether such an accounting choice matters. In contrast to SFAS 142, which requires the cumulative effect method, section 3062 requires that the retroactive method be used to account for the change in accounting policy (that is, adoption write-offs are charged to opening retained earnings rather than net income). Understanding managers' reporting choices in the context of equity recognition is important because the retroactive method's usage will rise in future years: In May 2005, the FASB issued SFAS 154 - Accounting Changes and Error Corrections - that requires the use of the retroactive method to account for changes in accounting principles for financial years starting on or after December 15, 2005.

We choose to focus on the adoption of SFAS 142/Ssection 3062 for a number of reasons. First, it was surrounded by controversy, mainly because it leaves considerable room for management interpretation, judgment, and bias both at the time of a merger and in future periods, and requires unverifiable estimates of the value of a firm and its implied goodwill (Massoud & Raiborn, 2003). …

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