Increasing Auditor Recognition of Goodwill Impairment Losses

Abstract

Auditing standards require auditors to evaluate the reasonableness of reported fair value estimates, but audit regulators frequently cite auditors for deficiencies in these estimates. Specific to goodwill, auditors must evaluate the probability that recorded goodwill is impaired. Based on small sample frames and availability theories, we predict that experiencing a recorded impairment at an unrelated client increases auditors’ internal perceived probability of downside risk. As a result, we expect more impairments at subsequent clients with economic indicators of impairment. Using a sample of 7,500 client-years from 2004-2014 with potential goodwill impairments, we find evidence consistent with our expectation at the audit office level. We also find evidence at the metropolitan statistical area and non-Big 4 audit firm levels; however, consistent with our expectation that the closer the auditor is to the prior impairment the stronger the effect, the audit office level effect is stronger than the other two levels and is especially strong in audit offices below the median size. Our study suggests that enhancing knowledge sharing around experienced goodwill impairments could help improve auditor difficulties in auditing uncertain fair value estimates and increase recognition of goodwill impairments.

Keywords: auditors, goodwill impairment, probability estimates, behavioral biases