DISCLOSURE ABOUT GOODWILL IMPAIRMENT TESTING AND AUDIT FEES

Abstract

This paper examines how goodwill impairment test and its disclosures of impairment test measurement process affect auditors’ risk assessments, through observing audit fees. Goodwill impairment is economically significant and its measurement of fair value estimates is complex and susceptible to less verification. Disclosures about the goodwill impairment process, on the one hand, may alleviate auditors’ concerns about the complexity and potential earnings manipulation through delayed or reduced goodwill impairment charges. On the other hand, auditors may have to increase manpower to perform audits and bear greater litigation costs for clients’ additional disclosures for goodwill impairment test. Because of these complications, I investigate (1) whether goodwill impairment measurement affects audit pricing due to its complexity and less reliable nature; (2) whether disclosures about goodwill impairment tests affect audit pricing; (3) whether the effects of disclosures on audit pricing vary with the degree of information asymmetry and investor scrutiny. I focus on disclosures about fair value estimates of goodwill in three dimensions: (1) merger and acquisition activities of the acquired business and segment affected by goodwill impairment, (2) fair value measurement methodology used by management for impairment test, (3) the inputs of fair value measurement used in the test. I find that goodwill is positively associated with audit fees, consistent with the fact that the complexity and potential risk for earnings manipulation in the measurement process of goodwill impairment increase audit effort and risk. I also find that disclosures about fair value estimates are positively related to audit fees, suggesting that perceived increased litigation risk faced by auditors outweighs decreased business risk due to such supplementary disclosures. However, in the additional analyses, I find a negative association between audit fees and disclosures about fair value estimates for firms (1) having more segments; (2) reporting goodwill impairment loss; and (3) having greater goodwill impairment loss. The findings indicate that, from auditors’ viewpoints, benefits of reduced business risk from clients’ supplementary disclosures about fair value estimates dominate costs of higher litigation risk in firms facing greater potential risk for earnings management and investor scrutiny.