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31 January 2019 CFA Institute Journal Review

Reviewing IFRS Goodwill Accounting Research: Implementation Effects and Cross-Country Differences (Digest summary)

  1. Butt Man-Kit, CFA

Determining the size and timing of goodwill is an accounting issue. Although the recognition, impairment, and disclosure of goodwill is standardized in countries that have adopted IFRS, cross-country differences in the implementation effects may persist.

How Is This Research Useful to Practitioners?

Goodwill arises from such factors as an entity’s good reputation and strong customer relationships, which are very significant assets. Conceptually, goodwill and firm value are positively related, but because goodwill valuation is governed by accounting standards, those standards’ requirements may affect the value relevancy and determinants of goodwill. Beginning in 2005, the EU began requiring the adoption of International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS) and was subsequently followed by Australia, Canada, and Malaysia, among other countries, so that IFRS 3 and IAS 36 now regulate the accounting treatment of goodwill.

Under IFRS 3, an impairment test is carried out annually in lieu of amortization. Thus, goodwill is only devalued when it is less valuable. This change in accounting may make goodwill more relevant to firm value. The authors review related academic studies to examine whether goodwill information is value relevant after IFRS adoption and to explore whether there are country differences regarding such relevancy. The results support the idea, on one hand, that goodwill information is value relevant, seemingly across countries and diverse influence factors. On the other hand, the results regarding the effects of IFRS adoption are not clear: Roughly one-half of the reviewed studies showed an increase in value relevance, whereas the other half showed a decrease in relevance after IFRS adoption.

Little evidence indicates that IFRS adoption enhances value relevance, except one sample study that showed that the increase in value relevance is greater when the difference between a country’s national GAAP and IFRS is large.

The authors further examine research on how country-level and firm-level factors affect a manager’s choice in goodwill recognition, impairment, and disclosure. Goodwill recognition is associated with economic and firm factors, including expected benefits from the combination and target firm value. One study showed that the association between goodwill and economic benefits is strong and that such economic benefits are enhanced by IFRS. A study conducted in Australia revealed that in the post-IFRS adoption period, the impairment-only approach greatly reduces analyst forecast error.

Most studies also support the result that the goodwill impairment amount is associated with a firm’s economic conditions. In contrast to observations in the United States, there is no obvious evidence that the impairment amount is manipulated for managerial incentives. Nonetheless, the association between goodwill impairment amount and a firm’s economic condition is stronger when the firm has stronger governance.

Future research should include more cross-country studies to explore the size and magnitude of the effect of such country-specific factors as legal system, legal enforcement, and culture on goodwill accounting choices.

How Did the Authors Conduct This Research?

The authors review the literature related to empirical studies on goodwill regarding the adoption of IFRS 3 and IAS 36. They select research only from academic journals. The final dataset comprises 42 papers in 27 academic journals published from 2008 to early 2017. Because of the limited number of cross-country studies, single-country studies are also included, and the authors attempt to find country differences by comparing the single-country studies.

To analyze the studies in their sample, the authors build a framework structured around input, action, and output. At the input stage, the sample studies are categorized into country-level and firm-level studies based on the factors that influence the goodwill accounting choices. The action stage refers to the research methods and techniques—for example, regression models and event studies. The output stage shows the observed consequences and is path dependent: Only when information is value relevant for investors are the corresponding determining factors investigated.

The authors then synthesize the findings from the sample studies and discuss the strengths and weaknesses of the various research methods. Finally, they attempt to identify the research gap and make recommendations on research methods to better control for time-sensitive effects.

Abstractor’s Viewpoint

The annual impairment test required by IFRS 3 and IAS 36 is logically superior to the previously used mechanical amortization because of the provision for more relevant and timely market value–based information. The authors establish a positive relationship between the size of goodwill and firm value across countries, but the country-level factors affecting the relationship are still largely unexplored.

The way investors perceive goodwill information may be one of the attributes that determines the value relevance. If investors are strongly confident that the goodwill value is correctly priced, then there may be a stronger association between goodwill and stock value. A market with stronger law enforcement, increased market transparency, and better ethics, governance, and trust culture might enhance investors’ confidence in reported goodwill value. These factors may be worthy of future research.

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