The Value Relevance of goodwill impairments: UK Evidence

Transcription

1 The Value Relevance of goodwll mparments: UK Evdence Naser M. AbuGhazaleh (Correspondng author) College of Busness Admnstraton, Gulf Unversty for Scence and Technology (GUST) P.O. Box 7207, Hawally, 32093, Kuwat Tel: E-mal: Osama M. Al-Hares College of Busness Admnstraton, Gulf Unversty for Scence and Technology (GUST) P.O. Box 7207, Hawally, 32093, Kuwat Tel: E-mal: Ayman E. Haddad College of Busness and Economcs Amercan Unversty of Kuwat (AUK) P.O Box 3323, Safat 13034, Kuwat Tel: E-mal: Receved: October 10, 2011 Accepted: November 30, 2011 Publshed: Aprl 1, 2012 do: /jef.v4n4p206 URL: Abstract Usng a sample of 528 frm-year observatons, drawn from the top 500 UK lsted frms for 2005 and 2006, ths study employs a multvarate ordnary least squares regresson to assess the value relevance of goodwll mparment losses followng the adopton of IFRS No. 3 Busness Combnatons. Emprcal results reveal a sgnfcant negatve assocaton between reported goodwll mparment losses and market value, suggestng that these mparments are perceved by nvestors to relably measure a declne n the value of goodwll and ncorporated n ther frm valuaton assessments. The study provdes evdence consstent wth IASB s objectves n developng the mparment-only standard and renforces the argument that, through IFRS 3, managers are more lkely to use ther accountng dscreton to convey prvately held nformaton about the underlyng performance of the frms. Keywords: Goodwll accountng, Imparment, Internatonal Fnancal Reportng Standards, Value relevance, EU. 1. Introducton On 31 March 2004, the Internatonal Accountng Standards Board (IASB), seekng nternatonal convergence and global harmonsaton, followed the US Fnancal Accountng Standards Board (FASB), and ssued IFRS 3, Busness Combnatons, (IASB, 2004a).IFRS 3 elmnates the use of the poolng of nterests method and prohbts the amortsaton of goodwll. Instead, t requres the testng for mparment to be performed annually or more frequently f events or changes n crcumstances ndcate that the asset mght be mpared. Wth the transton to nternatonal reportng standards, UK frms lsted on the man market had to dscontnue amortsng goodwll and account for t usng IFRS 3 snce Pror studes provde emprcal evdence that straght-lne amortsaton of goodwll over an arbtrary perod fals to provde useful nformaton to the users of the fnancal statements and nstead adds nose, makng t harder for nvestors to use the earnngs measure to predct future proftablty (e.g., Jennngs et al., 2001; Moehrle et al., 2001). The mparment approach to goodwll was ntroduced wth the ntenton of mprovng the nformaton content of reported acqured goodwll and provdng users of the fnancal statements wth value-relevant nformaton that more closely reflects the underlyng economc value of goodwll (Note 1). However, ths approach has been crtcsed by 206

2 practtoners, academcs and dssentng IASB members based on the manageral dscreton nherent n the mparment test. The mparment crtera provded by the standard are drafted n such a way that leave sgnfcant room for manageral dscreton, nterpretaton, judgement and bas (Massoud and Raborn, 2003). For example, Watts (2003, p. 217) crtcsed the mparment approach and argued that assessng mparment requres valuaton of future cash flows. Because those future cash flows are unlkely to be verfable and contractble, they, and valuaton based on them, are lkely to be manpulated. Standard setters suggest managers wll use the accountng dscreton permtted by the mparment approach to provde ther prvate nformaton about future cash flows, resultng n mparments that better reflect the underlyng performance of the frm. Alternatvely, managers may choose opportunstcally to explot ther accountng dscreton, resultng n mparments that do not adequately reflect the frm s underlyng economcs, and hence the purported beneft of the mparment-only approach s merely an lluson shared among standard setters. Based on the above debate, the prmary objectve of ths study s to examne the value relevance of goodwll mparments reported n the UK context followng the adopton of IFRS 3. The hypothess nvestgated s that these mparments are more lkely to reflect the provson of managers prvate nformaton about future cash flows f they are perceved by nvestors as suffcently relable measures of goodwll declnaton and used by them n ther market valuaton of the frm values. Alternatvely, goodwll mparments may not provde useful nformaton to the market n vew of the concerns rased by analysts and nvestors regardng the standard s mplementaton. Usng a sample of 528 frm-year observatons drawn from the top 500 UK lsted frms for fnancal years 2005 and 2006; ths study examnes the relatonshp between equty market value and goodwll mparment losses. Emprcal results reveal a sgnfcant negatve assocaton between reported goodwll mparment losses and market value, suggestng that these mparments are perceved by nvestors to be value relevant and ncorporated n ther frm valuaton assessments. Ths perceved relablty and value relevance of goodwll mparment losses may be nterpreted as early evdence that managers do n fact choose to exercse ther mparment dscreton to relably convey prvate nformaton on future cash flows. As such, the study further supports IASB s objectves n developng the mparment-only standard and renforces the argument that, through IFRS 3, managers are more lkely to use ther accountng dscreton granted under ths standard to convey prvately held nformaton about the underlyng performance of the frms, thereby mprovng the accountng for goodwll practces n partcular, and fnancal reportng among frms n general. The UK context provdes an early yet nterestng expermental settng to examne the value relevance of goodwll mparments for the followng reasons. Frstly, whle most pror studes focused on ether the cumulatve effect method or the retroactve method used to account for transtonal goodwll mparments n USA and Canada respectvely, ths study provdes emprcal evdence n relaton to goodwll mparments recorded on transton to IFRS 3 n the UK whch requres mparments to be recorded n ncome from contnung operatons (Note 2). The absence of specal transtonal accountng treatments n the UK suggests that goodwll mparments are less lkely to be affected by manageral ncentves specfc to the transton perod, and hence ncreases the generalsablty of the results. Secondly, n contrast to the US and Canadan GAAP, whereby a two-steps mparment test on goodwll s to be carred out, goodwll s tested for mparment at a lower level usng a one-step test under IFRS 3, thereby provdng less room for managers to manpulate the amount of goodwll and resultng n better nformaton provded to nvestors. Thrdly, ths study ncludes both mparers and non-mparers as ts sample for the emprcal tests n order to better examne the net benefts of the mparment-only approach under IFRS 3. Through such an approach, the lmtatons n pror studes as dentfed by Ramanna (2008) can be mtgated. Fnally, ths study may be one of the frst to provde early UK emprcal evdence that goodwll mparments reported followng the adopton of IFRS 3 are n fact value relevant, n the sense that they are perceved by nvestors to be relable measures of the reducton n the value of goodwll and are ncorporated nto the valuaton assessment of the frms. The remander of ths paper s organsed as follows. Secton 2 dscusses the background. Secton 3 presents the man fndngs of pror research. Secton 4 explans the research desgn employed. Secton 5 revews descrptve statstcs and emprcal results. Fnally, Secton 6 concludes. 2. Background Accountng for goodwll has been a controversal ssue n the UK. The frst attempt by the UK standard setter, SSAP 22 n 1984 (ASC, 1984), requred goodwll to be ether wrtten off aganst reserves (retaned earnngs) or captalsed and amortsed over an approprate perod. Ths attempt receved enormous crtcsms as t permtted two dfferent accountng treatments that were conceptually nconsstent (Hussey and Ong, 2000). The debate n the late 1990s n the UK led to the establshment of FRS 10 Goodwll and Intangble Assets (ASB, 1997), whereby goodwll must be captalsed and amortsed (wth trgger-based mparment tests) under a rebuttable presumpton that ts useful Publshed by Canadan Center of Scence and Educaton 207

3 economc lfe does not exceed 20 years from the date of acquston nstead of the mmedate wrte-off to reserves (Note 3). Wth the transton to nternatonal reportng standards n the UK n 2005, all frms lsted on the man market dscontnued amortsng goodwll and accounted for t usng the gudelnes specfed by IFRS 3 Busness Combnatons and IAS 36 Imparment of Assets (IASB, 2004b). Accordng to IAS 36, goodwll acqured n a busness combnaton should, from the date of acquston, be allocated to each of the acqurer s cash-generatng-unts, or groups of cash-generatng-unts that are expected to beneft from the synerges of the busness combnaton, rrespectve of whether other assets or labltes of the acquston are assgned to those unts or groups of unts. Each unt or groups of unts to whch goodwll s allocated should represent the lowest level wthn the entty at whch goodwll s montored for nternal management purposes, and not be larger than a segment based on ether the entty s prmary or secondary reportng format, accordng to IAS 14 Segment Reportng (Note 4) (superseded by IFRS 8 Operatng Segments effectve for annual perods begnnng 1 January 2009). A cash-generatng-unt to whch goodwll has been allocated shall be tested for mparment both annually and whenever there s an ndcaton that the unt may be mpared. If the recoverable amount of the unt exceeds the carryng amount of the unt, the unt and the goodwll allocated to that unt s not mpared. If nstead the carryng amount of the unt exceeds ts recoverable amount, the entty must recognse an mparment loss (Note 5). The recoverable amount of an asset or a cash-generatng-unt s whchever s the hgher of ts far value less costs to sell and ts value n use. The mparment loss s frst allocated to the goodwll of the cash-generatng-unt (groups of unts) before t s allocated to other assets wthn the unt (groups of unts) on a pro-rata bass, as long as t does not reduce any asset below the hghest of ts far value less costs to sell, ts value n use, and zero. The mparment loss s recognzed mmedately above the lne n the secton of ncome from contnung operatons (Note 6). Once recognsed, IAS 36 prohbts the recognton of reversals of mparment losses for goodwll n subsequent perods. Whle IFRS 3 forces managers to perform annual goodwll mparment tests and, at a lower level, usng a one-step test of mparment, t also provdes the opportunty for accountng dscreton by requrng managers to make a number of accountng choces. The most mportant of these are the determnaton of the cash-generatng unts, the subsequent allocaton of goodwll to these unts, and the recoverable amount estmates of the unts. Accordng to standard setters, such accountng treatment s expected to mprove the representatonal fathfulness of the goodwll fgures rather than that reported va straght-lne amortsaton over an arbtrary perod. They further argue that, through the mparment-only approach, more useful nformaton can be provded to users of an entty s fnancal statements (IASB, 2004a, BC140, p.142). However, practtoners and fnancal report users reman sceptcal over the motvatons for managers reportng choces. By exercsng dscreton nherent n IFRS 3, managers may, dependng on ther reportng ncentves, overstate, understate, or smply not recognse an exstng economc mparment loss by beng selectve wth respect to the underlyng choces they make when testng goodwll for mparment. Ths dscreton may be used to convey managers prvate nformaton about future cash flows. Alternatvely, t may be used opportunstcally to extract rents from other contractng partes resultng n mparments that are less reflectve of the frm s underlyng economcs. 3. Related Research The majorty of pror emprcal studes examnng the mpact of the amortsaton expense on share prces provde lttle evdence that t s of sgnfcant value to users. For example, Jennngs et al. (2001) examne whether total earnngs wth goodwll amortsaton s more nformatve than total earnngs before amortsaton. They fnd that earnngs before goodwll amortsaton explan sgnfcantly more of the observed dstrbuton of share prces than earnngs after goodwll amortsaton, and that goodwll amortsaton adds nose, makng t harder for nvestors to use the earnngs measure to predct future proftablty. Smlarly, Moehrle et al. (2001) fnd lttle evdence that goodwll amortsaton contans value-relevant nformaton, and suggest that the amortsaton dsclosures were not decson-useful, thereby supportng the FASB s choce of mparment tests for goodwll nstead of amortsaton (Note 7). In contrast, Ojala (2007) fnds that the goodwll amortsaton practce does provde relevant nformaton for nvestors, provded that amortsaton perods are suffcently short n order to better reflect the economc lfe of the underlyng asset. Studes that examne the market effects of wrte-offs can be dvded nto two prmary strands. The frst strand uses the nformaton content approach to examne the relaton between the announcement of a wrte-off and equty market reactons measured over a relatvely short perod surroundng the announcement date (Alcatore et al., 1998). The second strand s the assocaton studes whch examne the assocaton between the wrte-off amount and returns calculated over a longer nterval, such as a fnancal year (Alcatore et al., 1998). The majorty of pror studes use 208

4 the nformaton content approach, and examne the market reactons at the tme of the announcement of the wrte-off. The assumpton underlyng these studes s that f share prces change around the tme of wrte-off announcements, then these wrte-offs are value-relevant and useful for nvestment decson makng (Note 8). Strong and Meyer (1987), Ellot and Shaw (1998), Francs et al., (1996), and Bartov et al., (1998), are pror studes that, usng the nformaton content approach, report negatve stock market reactons at the announcement of asset wrte-offs. Among the studes that focus specfcally on goodwll wrte-offs, Hrschey and Rchardson (2003) fnd that the stock market reacton to 80 goodwll wrte-offs reported pror to the adopton of SFAS 142 s negatve and materal. Bens and Heltzer (2004) examne the nformaton content of goodwll wrte-offs recorded before, durng, and after the adopton of SFAS 142, and report a sgnfcant negatve stock market reacton to the announcements of goodwll wrte-offs before and after the adopton of SFAS 142. However, they also conclude that the market reacton to goodwll mparments recorded n the transton perod s sgnfcantly less negatve than the reacton to mparments recorded n later perods, clearly suggestng that the market beleves managers have acted strategcally n the transton year by wrtng off goodwll that was not yet mpared n order to take advantage of the one-tme below-the-lne treatment, and to present a more conservatve balance sheet. L et al., (2011) and Zang (2008) are two more recent emprcal studes on the nformaton content of transtonal goodwll mparments followng the adopton of SFAS 142. Usng a sample of US frms, these two studes are able to conclude that negatve abnormal returns are reported followng the announcement of goodwll wrte-offs. Furthermore, they fnd that fnancal analysts revse ther short-term and long-term earnngs forecasts downwards followng the announcements of goodwll mparment losses. Usng the assocaton approach, Chen et al. (2008) examne the value relevance of goodwll mparments reported durng and subsequent to the frst year of SFAS 142 adopton. They fnd that both the adopton and frst year mparments provded new nformaton to the market. They therefore conclude that SFAS 142 s net benefcal, consstent wth the objectves lad out by FASB when developng the standard. Wth a sample of Canadan frms, Laponte-Antunes et al. (2009) examne the value relevance and tmelness of transtonal SFAS 142 goodwll mparments recorded by these frms and fnd a negatve relatonshp between reported mparment losses and share prce. They then nterpret ther results as evdence that far value measurements can be relevant, even when the fnancal statement elements are nherently bound to measurement error and subject to sgnfcant manageral dscreton. Studes from both strands produced evdence to suggest that goodwll wrte-offs convey economcally meanngful nformaton to the nvestors about the frm s future proftablty. One mportant mplcaton to be drawn from these studes s that the mparment-only approach has mproved the qualty of reported nformaton on goodwll (as predcted by the standard setters) by provdng managers wth a framework to convey ther prvate future-cash-flow nformaton to markets (Note 9) (Note 10) However, t has to be noted that results of studes usng US and Canadan data from the transton perod have to be nterpreted wth cauton and may lack generalsablty snce managers, n recordng transtonal wrte-offs, may have had ncentves to act strategcally by ncreasng the amount of wrte-offs that are treated as merely an accountng change or charged to retaned earnngs, thereby decreasng the probablty and amount of future mparments that would be, f recorded, ncluded n ncome from contnung operatons (Beatty and Weber, 2006). For example, Bens and Heltzer (2004) report that the market s reacton to transtonal SFAS 142 goodwll mparments s sgnfcantly less negatve than ts reacton to mparments recorded n later perods, suggestng that US managers acted strategcally n the adopton year by wrtng off goodwll that was not yet mpared n order to take advantage of the one-tme below-the-lne treatment and present a more conservatve balance sheet. Smlarly, Jordan et al. (2007) fnd that U.S managers have cherry pcked the adopton year to aggressvely recognse goodwll mparment losses so that operatng ncome n future years would not be burdened wth these charges. Furthermore, Ramanna (2008) argues that these studes focus prmarly on explanng recorded mparments but have not consdered frms that have avoded mparments (p.255). Usng a sample that ncludes both mparers and non-mparers may therefore be a much better approach to arrve at conclusons on the net benefts of the mparment-only standards. Ths study relates to pror lterature n strand two, whch adopts the assocaton approach when examnng the value relevance of goodwll mparment losses. However, havng been made aware of the lmtatons of past research, ths study dffers from pror studes n two key aspects. Frstly, unlke prevous research, ths study focuses on IFRS 3 goodwll mparment losses reported n the UK context whch requres mparments to be recorded n the secton of ncome from contnung operatons, and hence are less susceptble to manageral ncentves specfc to the transton perod. Secondly, ths study ncludes both mparers and non-mparers as ts sample for the emprcal tests n order Publshed by Canadan Center of Scence and Educaton 209

5 to better examne the net benefts of the mparment-only approach under IFRS 3. Through such an approach, the lmtatons n pror studes as dentfed by Ramanna (2008) can be mtgated. These two key dfferences clearly demonstrate the further need and advantage for carryng out ths study examnng the value relevance of goodwll mparments n the UK context, whch, accordng to the authors best knowledge, has not been examned before. 3. Methodology 3.1 Sample Frms Table 1 presents the sample constructon process. The top 500 UK lsted frms by total market captalzaton as lsted by the Fnancal Tmes at 30 March 2007 are selected for the 2005 and 2006 fnancal years. Ths results n 1000 frm-year observatons. 254 observatons belongng to the Fnancals ndustry are then excluded, snce ther fnancal reportng processes as regulated ndustres tend not to match wth other ndustres. The dstncton between fnancals and non-fnancals s based on the Industry Classfcaton Benchmark system as gven by the London Stock Exchange (LSE). The excluson of the fnancal nsttutons results n 746 frm-year observatons. 80 observatons lsted on the LSE s Alternatve Investment Market (AIM) are further excluded, snce they are requred to adopt IFRS-based reportng for the frst tme after the 1st of January 2007 and were stll amortsng goodwll accordng to the provsons of the prevous UK GAAP, FRS 10. Ths process results n 666 frm-year observatons. Fnally 87 observatons wth no postve goodwll balances and 51 observatons that do not have the necessary data to run the tests are excluded. These procedures result n a fnal sample that conssts of 528 frm-year observatons, comprsed of 109 wrte-off (20.6% of sample) and 419 non-wrte-off observatons (79.4% of sample). Fnancal data for sample frms s obtaned from the Hemscott Premum Database, supplemented by the frms annual reports when necessary. Fnally, fnancal statements prepared n a currency dfferent from pounds sterlng are translated nto pounds usng the exchange rate at the balance sheet date. Insert Table 1 Here 3.2 Model and Varables To evaluate the value relevance of goodwll mparment losses, ths study adopts the model appled by Laponte-Antunes et al. (2009), known as an accountng-based valuaton model that s orgnally proposed by Ohlson (1995). Ths model vews the frm s market value as a functon of the book value of ts equty and ts earnngs. The valuaton model s then altered to separate goodwll and goodwll mparment losses from book value of equty and earnngs. The followng ordnary least squares regresson model s used to assess the value relevance of goodwll mparment losses: Where: MVAL BVAL MVAL 1BVAL 2PTP 3ECVGW 4 GILA e Frm s market value of equty at the end of the year n whch the goodwll mparment test s performed. Frm s book value of equty at the end of the year n whch the goodwll mparment test s performed mnus the carryng value of goodwll at the end of that same perod. PTP ECVGW GILA Frm s pre-tax proft at the end of the year n whch the goodwll mparment loss s recognzed plus the reported goodwll mparment loss. Frm s carryng value of goodwll at the end of the year n whch the goodwll mparment test s performed plus the reported goodwll mparment loss. Frm s reported goodwll mparment loss reflected as a postve number. GILA s 0 for frms the do not report goodwll mparments. Followng Laponte-Antunes et al. (2009), all varables ncluded n ths study are deflated by year-end total ordnary shares outstandng. Furthermore, the model above s corrected for heteroscedastcty usng Whte s heteroscedastcty-corrected varances and standard errors. Pror value relevance research suggests that the book of value of equty s a value-relevant factor that proxes for expected future normal earnngs (Ohlson, 1995). Smlarly, t has been argued that earnngs reflect nformaton about expected future cash flows (Note 11) (Kothar and Zmmerman, 1995; Ohlson, 1995). Consequently, the study expects the book value of equty (BVAL) and earnngs (PTP) to be postvely related to prce. Pror research on the value relevance of frms reported goodwll n USA and Australa provdes evdence of a postve assocaton 210

6 between frm value and goodwll (e.g., Jennngs et al., 1996; Godfrey and Koh, 2001; Hennng et al., 2000; Dahmash et al., 2009), suggestng that nvestors perceve that goodwll reflects an underpnnng economc value whch generates future economc benefts to the frm (Note 12). Consequently, the study expects a postve assocaton between the carryng value of goodwll (ECVGW) and prce. Fnally, pror research reports negatve correlatons between SFAS 142 wrte-offs and share prces (e.g., Chen et al., 2008; Laponte-Antunes et al., 2009). To the extent that nvestors perceve IFRS 3 goodwll mparments to be relable estmates of a reducton n the value of goodwll and to ncorporate these estmates n ther valuaton of frm values, the current study expects a negatve assocaton between goodwll mparments (GILA) and prce. 4. Emprcal Results 4.1 Descrptve Statstcs Table 2 provdes descrptve statstcs for the varables used n the multvarate OLS regresson examnng the value relevance of goodwll mparment losses. The table shows an average share prce of 5.21 and an average book value per share before goodwll of Sample frms have average earnngs per share before goodwll mparment of The average goodwll per share before goodwll mparment and the average goodwll mparment per share are 0.82 and 0.01, respectvely. The book value per share exceeds the market value for only 11 observatons. Out of these frms, 6 report goodwll mparment losses. Insert Table 2 Here Table 3 provdes Pearson correlatons for the varables used n the multvarate OLS regresson examnng the value relevance of goodwll mparments. As predcted, BVAL, PTP and ECVGW have sgnfcant postve correlatons wth MVAL. GILA has a negatve and nsgnfcant correlaton wth MVAL. Whle bvarate correlatons exst, the multvarate analyss offers advantages over bvarate correlatons on the grounds of ts ablty to control for the effects and nterrelatonshps between other ndependent varables. Fnally, Table 3 reveals that the ndependent varables are not hghly correlated wth one another. The hghest par-wse correlaton coeffcent s , suggestng that multcolnearty does not appear to be a problem n ths study. Insert Table 3 Here 4.2 Multvarate Results Table 4 reports the results of the OLS regresson examnng the value relevance of goodwll mparment losses. The model s sgnfcant (P-value < 0.001) wth an adjusted R² of 76.57%. The Durbn-Watson d statstc s not less than 1, ndcatng that autocorrelaton s not a serous problem (Note 13). Consstent wth the predctons of the study, the book value per share (BVAL), and earnngs per share (PTP) are postvely assocated wth share prce and the assocaton s sgnfcant (p= and p<0.001). In addton, goodwll per share (ECVGW) s postve and sgnfcant (p<0.001), provdng evdence consstent wth pror research (e.g., Jennngs et al., 1996; Hennng et al., 2000; Godfrey and Koh, 2001; Dahmash et al., 2009) and suggestng that goodwll reported by UK frms s value-relevant and perceved by nvestors to provde frms wth future economc benefts. Fnally, Table 4 reveals that the goodwll mparment loss per share (GILA) s negatve and sgnfcant (p<0.001), suggestng that the nformaton relatng to these mparments s ntegrated by nvestors n ther valuaton assessments of the frm. Ths result may be nterpreted as evdence that IFRS 3 has mproved the qualty of reported nformaton on goodwll by allowng managers to relably convey ther prvately-held future-cash-flow nformaton to markets, consstent wth the IASB s objectves n developng the mparment standard. Thus, the study provdes evdence consstent wth pror US and Canadan value relevance studes (e.g., Chen et al., 2008; Laponte-Antunes et al., 2009) but n a dfferent expermental settng. Insert Table 4 Here 5. Concluson Usng a sample of 528 frm-year observatons, drawn from the top 500 UK lsted frms for 2005 and 2006, ths study employs a multvarate ordnary least squares regresson to assess the value relevance of goodwll mparment losses reported by UK frms followng the adopton of IFRS 3 Busness Combnatons. Whle IFRS 3 was ssued to mprove the accountng treatment for goodwll and provde users wth more useful and value-relevant nformaton regardng the underlyng economc value of goodwll, practtoners and fnancal report users reman sceptcal over the motvatons for managers reportng choces. The hypothess nvestgated s that these mparments are more lkely to reflect the provson of managers prvate nformaton about future cash flows f they are perceved by nvestors as suffcently relable measures of goodwll declnaton and used by them n ther market valuaton of the Publshed by Canadan Center of Scence and Educaton 211

7 frm values. Alternatvely, goodwll mparments may not provde useful nformaton to the market n vew of the concerns rased by analysts and nvestors regardng the standard s mplementaton. Emprcal results reveal a sgnfcant negatve assocaton between reported goodwll mparment losses and market value, suggestng that these mparments are perceved by nvestors to relably measure a declne n the value of goodwll and are ncorporated n ther frm valuaton assessments. Contrary to crtcsms that surrounded the applcaton of the mparment-only approach, whch centred on whether the manageral dscreton afforded by such standards may be used by managers opportunstcally to dstort the underlyng economcs of the frm, the perceved relablty and value relevance of goodwll mparment losses documented n ths study may be nterpreted as early evdence that managers do n fact choose to exercse ther mparment dscreton to relably convey ther prvate nformaton on future cash flows. As such, the results should be of nterest to standard setters and academcs, as they provde further support to IASB s objectves n developng the mparment standard and renforce the argument that, through prncples-based standards (e.g., IFRS 3), managers are more lkely to use ther accountng dscreton to convey prvately-held nformaton about the underlyng performance of the frms. Fnally, the emprcal fndngs of ths study provde greater confdence to the fndngs of pror accountng research (e.g. Jennngs et al., 1996; Hennng et al., 2000; Godfrey and Koh, 2001; Dahmash et al., 2009) that the nformaton content of reported goodwll fgures s value relevant. Ths study s subject to the standard econometrc problems faced by most postvstc accountng researchers (e.g., errors n varables, omtted varables, sample selecton bas). The lmted number of years studed s also another lmtaton of the current research. Gven more years of fnancal statement data, t may be possble to examne the long-term effects of IFRS 3 on goodwll accountng and determne whether the conclusons of ths study hold over tme. References AbuGhazaleh, N., Al-Hares, O., & Roberts, C. (2011). Accountng Dscreton n Goodwll Imparments: UK Evdence. Journal of Internatonal Fnancal Management and Accountng, 22 (3) Accountng Standards Board. (1997). Fnancal Reportng Standard 10, Goodwll and Intangble Assets. Accountng Standards Board. (1998). Fnancal Reportng Standard 11, Imparment of Fxed Assets and Goodwll. Accountng Standards Commttee. (1984, 1989), Statement of Standard Accountng Practce 22, Accountng for Goodwll. Alcatore, M., Dee, C.C., Easton, P., & Spear, N. (1998). Asset Wrte-Downs: A Decade of Research. Journal of Accountng Lterature Andrews, R. (2006). Imparment of Assets: Measurement Wthout Dsclosure. The Chartered Assocaton of Certfed Accountants Research Report 92. Bartov, E., Lndahl, F. W., & Rcks, W. E. (1998). Stock Prce Behavour Around Announcements of Wrte-Offs. Revew of Accountng Studes.3 (4) Beatty, A., & Weber, J. (2006). Accountng Dscreton n Far Value Estmates: An Examnaton of SFAS 142 Goodwll Imparments. Journal of Accountng Research. 44 (2) Bens, D. A., & Heltzer, W. (2004). The Informaton Content and Tmelness of Far Value Accountng: An Examnaton of Goodwll Wrte-offs Before, Durng and After Implementaton of SFAS 142. Workng paper.unversty of Chcago. Chen, C., Kohlbeck, M., & Warfeld, T. (2008). Tmelness of mparment recognton: Evdence from the ntal adopton of SFAS 142. Advances n Accountng. 24 (1) Godfrey, J. M., & Koh, P. (2009). Goodwll Imparment as a Reflecton of Investment Opportuntes. Accountng and Fnance, 49 (1) Dahmash, F. N., Durand, R. B., & Watson, J. (2009). The Value Relevance and Relablty of Reported Goodwll and Identfable ntangble Assets. The Brtsh Accountng Revew, 41 (20) Deegan, C., & Unerman, J. (2006). Fnancal Accountng Theory. European Edton, McGraw-Hll, London, UK Ellott, J. A., & Shaw, W. H. (1998).Wrte-Offs as Accountng Procedures to Manage Perceptons. Journal of Accountng Research. 26 (Supplement 1998)

8 Francs, J., Hanna, J., & Vncent, L. (1996).Causes and Effects of Dscretonary Asset Wrte-offs. Journal of Accountng Research. 34 (Supplement 1996) Godfrey, J., & Koh, P. (2001).The Relevance to Frm Valuaton of Captalzed Intangble Assets n Total and by Category.Australan Accountng Revew.July Hennng, S. L., Lews, B. L., & Shaw, W. H. (2000). Valuaton of the Components of Purchased Goodwll. Journal of Accountng Research.38 (2) Hrschey, M., & Rchardson, V. J. (2003).Investor Underreacton to Goodwll Wrte-Offs. Fnancal Analysts Journal.59 (6) Hussey, R., & Ong, A. (2000).Can We Put a Value on a Name: The Problem of Accountng for Goodwll and Brands.Credt Control. 21 (1/2) Internatonal Accountng Standards Board. (2004a). Internatonal Fnancal Reportng Standard 3, Busness Combnatons. Internatonal Accountng Standards Board. (2004b). Internatonal Accountng Standard 36 (revsed), Imparment of Assets. Jarva, H. (2009). Do Frms Manage Far Value Estmates? An Examnaton of SFAS 142 Goodwll Imparments. Journal of Busness Fnance and Accountng, 36 (9-10) Jennngs, R., LeClere, M., & Thompson, R. (2001). Goodwll Amortsatonand the Usefulness of Earnngs.Fnancal Analysts Journal.57 (5) Jennngs, R., Robnson, J., Thompson, R. B., & Duvall, L. (1996). The Relaton between Accountng Goodwll Numbers and Equty Values.Journal of Busness Fnance and Accountng.23 (4) Jordan, C. E., Clark, S. J., & Vann, C. E. (2007). Usng Goodwll Imparment to Effect Earnngs Management durng SFAS No. 142 s Year Of Adopton And Later. Journal of Busness and Economc Research.5 (1) Kothar, S. P., & Zmmerman, J. (1995). Prce and Return Models. Journal of Accountng and Economcs.20 (2) Laponte-Antunes., P., Cormer, D., & Magnan, M. (2008). Equty Recognton of Mandatory Accountng Changes: The Case of Transtonal Goodwll Imparment Losses. Canadan Journal of Admnstratve Scences, 25 (1) Laponte-Antunes., P., Cormer, D, & Magnan, M. (2009). Value Relevance and Tmelness of Transtonal Goodwll-Imparment Losses: Evdence from Canada. Internatonal Journal of Accountng.44 (1) L, Z., Shroff, P. K., Venkataraman, R., & Zhang, I. (2011). Causes and Consequences of Goodwll Imparment Losses. Revew of Accountng Studes. 16 (4) Massoud, M. F., & Raborn, C. A. (2003). Accountng for Goodwll: Are we better Off?.Revew of Busness.24 (2) Moehrle, S. R., Reynolds-Moehrle, J. A., & Wallace, J. S. (2001). How Informatve are Earnngs Numbers that Exclude goodwll Amortsaton?.Accountng Horzons. 5 (3) Ohlson, J. (1995). Earnngs, Book Values and Dvdends n Equty Valuatons.Contemporary Accountng Research.11 (2) Ojala, H. (2007). The Value Relevance of Accountng Goodwll-Does the Abandonment of Systematc Amortsaton Make A Sense to Investors?.Fnnsh Journal of Busness Economcs. 1/ Paterson, R. (2002). Stranng Goodwll. Accountancy.London, 129 (1306) Ramanna, K. (2008). The Implcatons of Unverfable Far-Value Accountng: Evdence from the Poltcal Economy of Goodwll Accountng. Journal of Accountng and Economcs. 45 (2-3) Strong, J. S., & Meyer, J. R. (1987).Asset Wrtedowns: Manageral Incentves and Securty Returns. The Journal of Fnance.42 (3) Publshed by Canadan Center of Scence and Educaton 213

9 Watts, R. L. (2003).Conservatsm n Accountng. Part 1: Explanatons and Implcatons. Accountng Horzons.17 (3) Zang, Y. (2008). Dscretonary Behavour wth Respect to the Adopton of SFAS No. 142 and the Behavour of Securty Prces.Revew of Accountng and Fnance.7 (1) Notes Note 1. In explanng how IFRS 3 mproves fnancal reportng, the IASB (2004a, BC 140, 142) argues that straght-lne amortsaton of goodwll over an arbtrary perod fals to provde useful nformaton. The Board noted that both anecdotal and research evdence supports ths vew The Board reaffrmed the vew t reached n developng ED 3 that f a rgorous and operatonal mparment test could be devsed, more useful nformaton would be provded to users of an entty s fnancal statements under an approach n whch goodwll s not amortsed, but tested for mparment annually or more frequently f events or changes n crcumstances ndcate that the goodwll mght be mpared. Note 2. The US SFAS 142 gave frms a reportng beneft by allowng them to report transtonal goodwll mparments below-the-lne as the effects of changes n accountng prncples, whle the Canadan GAAP (Secton 3062) allowed frms to use the retroactve method and charge transtonal goodwll mparments to openng retaned earnngs rather than net ncome Note 3. FRS 10 allowed goodwll to have a useful economc lfe of greater than 20 years, or even an ndefnte one, but only when t s expected to be capable of contnued measurement. Where goodwll s regarded as havng an ndefnte useful economc lfe, t should not be amortsed. If goodwll s not amortsed, or f t s amortsed over a perod of more than 20 years, then an mparment revew must be performed each year to ensure that the carryng value of the goodwll does not exceed ts recoverable amount n accordance wth FRS 11 Imparment of Fxed Assets and Goodwll (ASB, 1998). However, the way that UK frms appled the requrements of FRS 10 and FRS 11 was regarded as slghtly surprsng, gven ther long-standng hostlty to amortzng goodwll: most of them chose the amortsaton route n order to avod the complextes of the full-blown mparment testng regme (Paterson, 2002, p 102). Andrews (2006) also reports that the majorty of large UK frms n the 2004 fnancal year have selected 20 years as the fnte useful economc lfe for goodwll and have amortsed the asset over ts fnte lfe. Note 4. In decdng not to converge wth SFAS 142 on the level of the goodwll mparment test, the Board noted that several North Amercan round-table partcpants expressed a hgh level of dssatsfacton at beng prevented by SFAS 142 from recognsng goodwll mparments that they knew exsted at levels lower than reportng unts (as defned by SFAS 142), but whch dsappeared once the lower level unts were aggregated wth other unts contanng suffcent cushons to offset the mparment loss (IASB, 2004b, BC 149). Note 5. In developng IAS 36, the Board consdered convergng fully wth SFAS 142. However, the Board was concerned that the two-step approach requred by SFAS 142 would not provde better nformaton than an approach under whch goodwll s tested for mparment at a lower level usng a one-step test (thereby removng many of the cushons protectng the goodwll from mparment) and concluded that the complexty and costs of applyng a two-step approach would outwegh any benefts of that approach. For example, f the carryng amount of a cash-generatng unt that contans goodwll exceeds ts far value, frms are requred to report an mparment loss under IAS 36. However, under SFAS 142, US frms that fal the frst step can stll avod recordng an mparment loss f the mpled far value of goodwll exceeds ts carryng value. Note 6. In developng IAS 36, the Board consdered whether IAS 36 should nclude a transtonal goodwll mparment test smlar to that ncluded n SFAS 142. The Board argued that the only possble stuaton n whch a transtonal mparment test mght gve rse to the recognton of an mparment loss would be when goodwll beng amortsed over a perod not exceedng 20 years was mpared n the absence of any ndcator of mparment that would requre an mparment test. Gven the rare crcumstances n whch ths ssue would arse, the Board concluded that the beneft of applyng a transtonal goodwll mparment test would be outweghed by the added costs of the test, and decded that the revsed verson of IAS 36 should not requre a transtonal goodwll mparment test (IASB, 2004b, BC ). Note 7. Moehrle et al. (2001) fnd that accountng earnngs wth or wthout amortsaton are equally nformatve and provde smlar value relevance when related to market returns. Note 8. Captal market research n accountng assumes that equty markets are sem-strong form effcent, n whch all publcly avalable nformaton, ncludng that avalable n frms fnancal statements and other fnancal dsclosures, s rapdly and fully reflected nto share prces as t s released (Deegan and Unerman, 2006). 214

10 Note 9. Ramanna (2008, p. 255) casts doubts on the net beneft conclusons of these studes and provdes alternatve explanatons for the perceved negatve stock market reacton. Imparments are ether utlsed as a bg bath strategy, or by management s ncompetence to avod losses despte SFAS 142 s dscreton potental. In both cases, the mparments are provdng new nformaton to markets, but not because the mparment approach has provded a framework for managers to relably report ther prvate nformaton. Note 10. Another stream of lterature examnes managers use of dscreton n determnng goodwll mparment losses followng the mandatory adopton of the mparment-only approach n USA, Canada and the UK (Laponte-Antunes et al., 2008; Godfrey and Koh, 2009; Jarva, 2009; AbuGhazaleh et al., 2011). These studes fal to fnd evdence that managers are opportunstcally usng ther accountng dscreton to dstort the underlyng economcs of the frms and conclude that the ntroducton of the mparment approach has enabled managers to convey ther prvate nformaton about future cash flows consstent wth the standard setters objectves n developng the mparment standards. These studes provde further support to the hypothess nvestgated n ths study. Note 11. Snce the market s expectaton of future cash flows are unobservable, emprcal specfcatons of the prce-earnngs relaton often use current earnngs as a proxy for the market s expectaton (Kothar and Zmmerman, 1995, p. 156). Note 12. However, Hennng et al. (2000) decompose goodwll nto gong concern, synergy, and resdual components (overpayments). The resdual component s measured as the dfference between reported goodwll and the gong concern and synergy components. Regressng the market value of equty on the three components reveals that the resdual component s negatvely related to market value, suggestng that the market treats overpayments as an expense at the tme of the acquston. Note 13. Correctng the results for frst order autocorrelaton mproves the Durbn-Watson d statstc and does not change the nferences on any of the varables (untabulated). Table 1. Sample Constructon* Frm- Year Observatons Top 500 UK lsted frms by market captalzaton (as lsted by the Fnancal Tmes at 30 March 2007) for the and 2006 fnancal years. (-) observatons related to the Fnancals ndustry (254) (-) observatons lsted on the Alternatve Investment Market (80) (-) observatons wth no postve goodwll balances (87) (-) observatons wth nsuffcent/ mssng data (51) Fnal Sample 528 Goodwll mparers 109 (20.6 %) Non goodwll mparers 419 (79.4 %) *Ths table presents the constructon process for the fnal sample used to examne the value relevance of goodwll mparments. Table 2. Descrptve statstcs * Varable ** N Mean Medan Mnmum Maxmum MVAL BVAL PTP ECVGW GILA *Ths table provdes descrptve statstcs for the varables used n the multvarate OLS regresson examnng the value relevance of goodwll mparments. **Varable defntons (all varables are deflated by year-end total ordnary shares outstandng) MVAL The marketvalue of equty at the endof the year n whch the goodwll mparment test s performed. BVAL The book value of equty at the end of the year n whch the goodwll mparment test s performed mnus the carryng value of goodwll at the end of that same perod. Publshed by Canadan Center of Scence and Educaton 215

11 PTP ECVGW GILA The pre-tax proft at the end of the year n whch the goodwll mparment loss s recognzed plus the reported goodwll mparment loss. The carryng value of goodwll at the end of the year n whch the goodwll mparment test s performed plus the reported goodwll mparment loss. The reported goodwll mparment loss reflected as a postve number. GILA s 0 for frms the do not report goodwll mparments. Table 3. Pearson correlatons* Varable** MVAL BVAL PTP ECVGW GILA MVAL BVAL PTP ECVGW GILA P= P=0.003 P=0.056 *Ths table provdes Pearson correlatons for the varables used n the multvarate OLS regresson examnng the value relevance of goodwll mparments. ** The varable defntons are reported n Table 2. Table 4. Value relevance of goodwll mparment losses* Varable** Predcton Coeffcent T-Statstc P-Value*** Intercept? < BVAL PTP < ECVGW < GILA < Adjusted R² 76.57% Model F Test P-Value < Durbn-Watson statstc *Ths table presents the results of the OLS regressons examnng the value relevance of goodwll mparment losses. The above results are corrected for heteroscedastcty usng Whte s heteroscedastcty-corrected varances and standard errors provded by LIMDEP. The model uses a sample of 528 frm-year observatons over the perod (109 wrte-off observatons and 419 non-wrte-off observatons). The parameter estmates are based on the followng model: MVAL ** The varable defntons are reported n Table 2 ***One-taled. 1BVAL 2PTP 3ECVGW 4 GILA e 216