Does the Financial Reporting for Income Tax Expense Affect Financial Reporting Quality? Evidence from the Timeliness of Goodwill Impairments

• In Event: Timeliness of Reporting Bad News and Misstatements

Abstract

Goodwill impairments are an important signal of expected future cash flows, yet their timing is subject to managers’ discretion. U.S. GAAP requires firms to test all goodwill for impairment but tax laws do not always allow deductions for goodwill. Thus, financial reporting tax benefits partially offset the negative GAAP earnings effect of impairments of tax-amortizable goodwill whereas there are no financial reporting tax benefits to offset the negative GAAP earnings effect of impairments of non-tax-amortizable goodwill. Holding the size of the impairment constant, impairments of non-tax-amortizable goodwill have a more negative effect on GAAP net earnings than impairments of tax-amortizable goodwill. We examine whether these differences in financial reporting for income taxes affect the timeliness of goodwill impairments.We predict and find that impairments of tax-amortizable goodwill are 16 to 20 percent less likely to be untimely than impairments of non-tax-amortizable goodwill. Furthermore, impairments of tax-amortizable goodwill are more untimely when firms record valuation allowances that negate the financial reporting tax benefits. This evidence suggests financial reporting for income tax expense affects financial reporting quality.

Authors

• Zachary Joseph King, University of Wisconsin - Madison

• Daniel Patrick Lynch, University of Wisconsin-Madison

• Bridget Stomberg, Indiana University - Bloomington

• Steve Utke, University of Connecticut