How Do Auditors Weight the Probability of Downside Risk? The Case of Goodwill Impairment

• In Event: Auditing Accounting Estimates

Abstract

Audit standards require auditors to evaluate the reasonableness of management’s estimates of the fair values of intangible assets, including goodwill. In the case of goodwill, auditors must evaluate the probability that recorded goodwill is impaired. We use psychology theory to hypothesize that auditors are less likely to underestimate the probability of impairment when they have encountered an impairment at another client, in which case they are more likely to make errors that are less favorable to a client compared to the economic factors predicting impairment. Using a sample of 4,998 client years from 2004-2010 with potential goodwill impairments, we find evidence consistent with our expectations at both the audit firm level and the audit office level, with the audit office level being incremental to the audit firm level. Our study has implications for delays in goodwill impairment recognition and for understanding auditor difficulties in auditing critical accounting estimates involving uncertainty.

Authors

• Matthew David Baugh, University of Missouri-Columbia

• Elaine G. Mauldin, University of Missouri-Columbia