Auditing Goodwill in the Post-Amortization Era: Challenges for Auditors

The Financial Accounting Standards Board’s adoption of SFAS 142 brought about significant change in how companies are required to account for goodwill. This change in accounting also brought with it new challenges for auditors, namely evaluating the reasonableness of management’s assumptions related to goodwill valuation. In addition to introducing technical challenges, this task is particularly difficult given the misalignment in incentives it creates between managers who likely prefer to avoid recording an impairment and auditors who seek to minimize the bias in management’s impairment testing. This study focuses on the misaligned incentives that auditors face under the current goodwill assessment process. Consistent with the presence of significant friction with clients, we find that the decision to record a goodwill impairment is associated with an increase in the probability of auditor dismissal. Our results also indicate that the likelihood of auditor dismissals is positively related to how unfavorable the impairment decision is for the client. Furthermore, we find that companies impairing goodwill prior to dismissing auditors subsequently employ auditors that are, on average, more favorable to clients in their impairment decisions. The results of our study should be of interest to regulators such as the Public Company Accounting Oversight Board as they attempt to both understand and reduce the challenges auditors face in auditing goodwill.