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Has Goodwill Accounting Gone Bad?

Last Updated on 10 February, 2024 by Rejaul Karim

In the realm of accounting practices, the transition from SFAS 141 to SFAS 142 marked a significant shift in the treatment of goodwill.

Kevin K. Li and Richard G. Sloan delve into this transformation in their paper, “Has Goodwill Accounting Gone Bad?” With SFAS 142 abolishing periodic amortization and introducing a fair-value-based impairment test, the authors scrutinize its impact on goodwill accounting and valuation.

Their findings unveil a scenario of inflated goodwill balances and delayed impairments, prompting a closer examination of managerial discretion. Notably, the study highlights how post-SFAS 142 goodwill impairments, often untimely and unforeseen by investors, contribute to temporary inflation of earnings and stock prices.

Abstract Of Paper

Prior to SFAS 142, goodwill was subject to periodic amortization and a recoverability-based impairment test. SFAS 142 eliminates periodic amortization and imposes a fair-value-based impairment test. We examine the impact of this standard on the accounting for and valuation of goodwill. Our results indicate that the new standard has resulted in relatively inflated goodwill balances and untimely impairments. We also find that investors do not appear to fully anticipate the untimely nature of post-SFAS 142 goodwill impairments. Overall, our results suggest that, in practice, some managers have exploited the discretion afforded by SFAS 142 to delay goodwill impairments, causing earnings and stock prices to be temporarily inflated.

Original paper – Download PDF

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Author

Kevin K. Li
Santa Clara University

Richard G. Sloan
University of Southern California – Leventhal School of Accounting

Conclusion

In summary, the transition from periodic amortization and recoverability-based impairment testing to SFAS 142’s fair-value-based impairment test has brought about notable implications for goodwill accounting and valuation. The findings reveal a tendency toward relatively inflated goodwill balances and delayed impairments under the new standard.

Notably, the untimeliness of post-SFAS 142 goodwill impairments is not fully anticipated by investors. This observation suggests that, in practice, managers have exercised discretion under SFAS 142 to defer goodwill impairments, contributing to temporary inflation of earnings and stock prices.

The study underscores the practical impact of accounting standards on managerial behavior and the consequential effects on financial reporting and market valuations.

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FAQ

1. What major changes did SFAS 142 bring to goodwill accounting, and how did it impact the treatment of goodwill?

SFAS 142 marked a significant shift in goodwill accounting by eliminating periodic amortization and introducing a fair-value-based impairment test. The paper by Kevin K. Li and Richard G. Sloan, “Has Goodwill Accounting Gone Bad?” examines the impact of this transition, revealing notable implications for the treatment of goodwill. The standard resulted in relatively inflated goodwill balances and introduced untimely impairments, prompting a closer look at managerial discretion.

2. How did SFAS 142 influence the timing of goodwill impairments, and what is the observed effect on earnings and stock prices?

The study indicates that post-SFAS 142 goodwill impairments tend to be delayed and, importantly, are often unforeseen by investors. This untimely recognition of impairments contributes to a temporary inflation of both earnings and stock prices. The paper sheds light on the practical consequences of the accounting standard, suggesting that managers may have utilized the discretion allowed by SFAS 142 to defer goodwill impairments.

3. What does the research reveal about the investor anticipation of post-SFAS 142 goodwill impairments, and what are the broader implications of these findings?

The findings suggest that investors do not fully anticipate the untimely nature of post-SFAS 142 goodwill impairments. This observation underscores the practical impact of accounting standards on financial reporting and market valuations. The research by Li and Sloan highlights the importance of understanding how changes in accounting practices, such as the shift introduced by SFAS 142, can influence managerial behavior, financial reporting dynamics, and investor expectations.

You can find many more Research Papers here

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