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

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 worldwide do not always allow goodwill deductions. As such, financial reporting tax benefits partially offset the negative GAAP earnings effect of impairments only for tax-amortizable goodwill and not for impairments of non-tax-amortizable goodwill. Holding the size of the impairment constant, the GAAP net income effect is therefore more negative for impairments of non-tax-amortizable goodwill than impairments of tax-amortizable goodwill. We predict and find that impairments of tax-amortizable goodwill are 16 to 20 percent less likely to be delayed than impairments of non-tax-amortizable goodwill. We also find impairments of tax-amortizable goodwill are more delayed when firms record valuation allowances that negate financial reporting tax benefits. Our findings suggest financial reporting for taxes potentially distort the timeliness of goodwill impairments.

Keywords: Mergers and Acquisitions, Goodwill, Tax, Impairment, Intangible, Earnings Quality

JEL Classification: G34, K34, M41