The Delay in Recognizing Goodwill Impairment: Flawed Audit Process or Insufficient Effort?

• In Event: Banks, Loans, and Goodwill

Abstract

Prior research finds that economic indicators of goodwill impairment precede the actual recognition of impairment for up to four years (Hayn and Hughes 2006; Li et al. 2011; Ramanna and Watts 2012; Li and Sloan 2014). Griffith et al. (2015) suggest that auditors’ inability to properly audit fair value estimates is potentially the result of the auditor using a flawed process and/or an overreliance on management assertions (i.e., inadequate effort). I examine whether the delay in recognizing goodwill impairment is associated with the use of a flawed audit process or insufficient audit effort. I identify companies with unrecognized goodwill impairment using a logistic model and match them with companies that had no unrecognized goodwill impairment and companies that recognized goodwill impairment. Utilizing fees as a proxy for audit effort, I provide evidence that auditors put forth more effort to test goodwill in companies with unrecognized and recognized impairment than companies with no unrecognized impairment. In addition, I find that auditors put forth the same level of effort for unrecognized and recognized impairment companies. This is consistent with auditors putting forth more effort when indicators of impairment are present regardless of whether impairment is recognized. Combined with Griffith et al. (2015) my results suggest while insufficient effort may play some role in the delay in recognizing goodwill impairment, the use of a flawed audit process is most likely the primary explanation.

Author

• Trevor Sorensen, West Virginia University