Scale of Goodwill Impairment and Audit Charge
Yanru Wang
*
a
and Yuju Li
b
Bejing Jiaotong University, China
Keywords: Goodwill Impairment, Audit Fees, Surplus Management.
Abstract: In the capital market, auditors perform forensic evaluation of accounting information and express independent
audit opinions. Based on the agency theory, stakeholder theory and large sample empirical method, this paper
selects A-share listed companies from 2014 to 2021 as samples to deeply analyze the impact of the scale of
goodwill impairment on the pricing level of audit services, in order to provide empirical evidence for
accounting information users. The results show that the larger the size of goodwill impairment provision
made by clients, the higher the pricing of audit fees in the current year, and the auditor maintains a higher
level of prudence. It is recommended that audits should focus on the subsequent measurement risk of
goodwill, give full play to the external oversight function of audits, and enhance the signaling effect of audit
pricing on the capital market.
1 INTRODUCTION
While the Chinese economic market continues to
expand, mergers and acquisitions have also led to the
accumulation of large amounts of goodwill in the
capital market in a few short years, and the risk of
large goodwill impairment charges is hidden behind
high goodwill. Essentially, the goodwill recognized
in the consolidated statements of operations arises
from the difference between the cost of the merger
and the fair value of the identifiable net assets of the
acquiree acquired in the merger, which is a kind of
merger premium paid by the listed company for the
value creation ability and market development
prospect of the acquire. Although goodwill is an asset
class, it cannot be realized due to its own properties
and cannot be reversed once a provision for goodwill
impairment is made. As an unidentifiable,
unverifiable and non-physical asset, it is highly
subjective and complex, making it difficult to
accurately estimate the fair value of goodwill assets.
In addition, in 2006, China implemented new
accounting standards and adopted the practice of
convergence with international accounting standards
for the recognition and subsequent measurement of
goodwill in business combinations by withdrawing
the amortization of goodwill and replacing it with
a
https://orcid.org/0000-0002-7512-4708
b
https://orcid.org/0000-0002-2558-5063
impairment testing only. Enterprises should
determine whether there is an indication of
impairment at the balance sheet date and perform
impairment tests at least at the end of each year.
Goodwill impairment in the capital market has been a
frequent lightning rod in recent years, with financial
fraud occurring from time to time and investors and
regulators questioning the CPA as the gatekeeper of
the capital market.
The existing literature generally considers the
impairment of M&A goodwill as a negative risk
matter, which will adversely affect listed companies.
Empirical studies have found that impairment of
goodwill implies that the excess premium paid in
M&A restructuring of listed companies does not
bring real benefits to the companies, but also provides
room for management to manage surplus to some
extent (Goncalves et.al., 2019), causing poorer
company performance (Glaum et.al., 2018) and
triggering drastic fluctuations in stock prices in the
market (Knauer and Woehrmann, 2016),
exacerbating the risk of sharp fluctuations in the
company's future share price (Han et al., 2019),
increasing the company's debt financing costs (Xu et
al., 2017), and leading to the generation of pessimism
among investors, analysts, and other stakeholders (Li
et.al. 2011). In fact, the goodwill impairment of
198
Wang, Y. and Li, Y.
Scale of Goodwill Impairment and Audit Charge.
DOI: 10.5220/0012028000003620
In Proceedings of the 4th International Conference on Economic Management and Model Engineering (ICEMME 2022), pages 198-203
ISBN: 978-989-758-636-1
Copyright
c
2023 by SCITEPRESS – Science and Technology Publications, Lda. Under CC license (CC BY-NC-ND 4.0)
mergers and acquisitions has been one of the major
risks of listed companies and capital markets that the
CSRC, the Ministry of Finance and other government
regulatory departments focus on. CSRC has
repeatedly urged accounting firms and market
intermediaries to strengthen supervision to prevent
the risks associated with large-scale goodwill
impairment charges by listed companies. It can be
seen that the goodwill impairment of mergers and
acquisitions of listed companies may not only be an
accounting confirmation behavior, but also may lead
to the risk of material misstatement of the company
and the risk of management information disclosure
violation, which will bring uncertainty to the external
stakeholders of the company and the capital market.
Auditors, as the assurance evaluators of accounting
information of listed companies, have clients with
huge goodwill impairment triggering higher risk of
audit failure. In terms of audit risk response,
established literature suggests that increasing audit
procedures, expanding audit scope, and devoting
more audit hours to obtain sufficient and appropriate
audit evidence are indispensable work elements for
auditors to reduce the risk of material misstatement at
the financial reporting determination level and thus
reduce audit risk, so whether auditors will require an
increase in audit fees as cost compensation and
whether the size of goodwill impairment charged by
the enterprise in the current year affects audit pricing
in the current year, there is less research in the
existing literature.
In view of this, this paper empirically examines
the relationship between M&A goodwill impairment
and audit fees for listed companies, using a sample of
Chinese A-share listed companies over the period
2014-2021, with a view to interpreting the
information content contained in M&A goodwill
impairment for listed companies from the perspective
of auditors' risk decisions.
2 LITERATURE REVIEW
Regarding the factors influencing audit fees, an
analysis of the impact of audit pricing based on the
cost hypothesis suggests that firm characteristics,
client characteristics, and government regulation all
affect audit pricing. Overall, audit costs are higher
and audit pricing is higher when accounting firms
provide audit services to clients with large firms and
complex organizational structures and operations.
Chen et al. (2010) argue that institutional advances
have led firms to focus less on the financial benefits
derived from auditing clients and more on the audit
cost factor invested in ensuring audit quality. When
firms have industry expertise and higher reputation,
the transmission of economies of scale becomes more
pronounced, triggering a decrease in audit pricing
levels (Chen and Ma, 2013). Therefore, cost savings
from economies of scale and learning curve effects
provide the possibility for firms to reduce audit
pricing (Yu et al., 2020).
Regarding the relationship between goodwill
impairment and audit pricing, M&A goodwill
impairment is prone to higher risks and negative
economic consequences. The cost of goodwill
generated by high premium M&A can enhance the
firm's current operating performance, but there is a
lag in the negative impact of goodwill cost on firm
performance (Zheng et al., 2014), and the higher the
M&A premium rate, the weaker the economic
synergy effect, the greater the possibility of triggering
goodwill impairment and the greater the stock return
volatility (Liu and Wang, 2019), increasing the risk
of stock price collapse (Liu et al., 2019). Auditing
should play an external monitoring role in the
impairment of M&A goodwill. On the one hand, an
effective reputation mechanism can motivate
accounting firms to provide high-quality audit
reports, and accounting firms that provide high audit
quality can receive a fee premium (Liu et al., 2018).
In addition, when the auditor faces a high enough
audit risk, the accounting firm devotes more total
audit time and more higher staff level audit time to
high-risk engagements (Bell et.al., 2008), and
according to the cost-benefit theory, the firm will
charge more audit fees to the audited entity.
Some scholars study the impact of goodwill on
audit fees, for example, Zheng and Li (2018)
empirically analyze that the ratio of goodwill opening
balance to assets positively affects audit fees in the
case of positive or negative surplus management. Ye
et al. (2016) argue that the complexity and
subjectivity of goodwill impairment testing leads
firms to invest in greater audit costs, resulting in
higher audit fees. The current period premium M&A
generates additional goodwill, and auditors charge a
risk premium for audits in response to the massive
goodwill impairment charged by clients, thus
increasing audit pricing. Based on this, this paper
proposes the hypothesis.
H1: Other things being equal, the larger the
goodwill impairment charged in the period, the higher
the audit fee.
Scale of Goodwill Impairment and Audit Charge
199
3 RESEARCH DESIGN
3.1 Sample Selection and Data Sources
This paper uses Chinese A-share listed enterprises
from 2014 to 2021 as the research object, and further
screened to ensure the reasonableness of the data:
excluding enterprises in the financial industry;
excluding enterprises with all 0 goodwill impairment
provisions during the sample period; enterprises with
missing data on the main variables during the sample
period and those listed after 2017. Finally, to guard
against the impact of extreme values on our study, 1%
and 99% quantile tailing was applied to all continuous
variables, and a total of 10,319 valid data were
obtained for 1175 firms. All variable data were
obtained from the Cathay Capital database
(CSMAR).
3.2 Sample Selection and Data Sources
3.2.1 Explained Variable: Audit Fees (Afee)
The natural logarithm of audit fees paid by the firm in
the current period is used to measure, which has been
determined to be basically in line with the normal
distribution.
3.2.2 Explanatory Variable: Goodwill
Impairment Size (IG)
The provision for goodwill impairment in the notes to
the financial statements was directly adopted as a
proxy for goodwill impairment, and the classification
of goodwill impairment of size was made on this
basis, which consisted of two indicators: the natural
logarithm of the provision for goodwill impairment of
the enterprise in the current year was adopted (IG1);
the ratio of the provision for goodwill impairment of
the enterprise to the total assets of the enterprise in the
current year was adopted (IG2).
3.2.3 Control Variables
The size of the enterprise (Size), the previous period's
surplus position (Isloss), the type of accounting firm
(Big4), the degree of surplus management (EM, as
measured by the modified Jones model), the asset-
liability ratio (TDR), and the equity pledge (Gqzz) are
selected, and the specific indicators are described in
Table 1.
Table 1: Variable definition table.
Type Variable Symbol Calculation Method
Explained variables Audit fees AFee
Natural logarithm of audit fees paid in the
current year
Explanatory variables
Size of goodwill
impairment
IG1
Natural logarithm of goodwill impairment
provision in the current year
IG2
Ratio of provision for goodwill impairment
to total assets of the firm in the current yea
r
Control variables
Size of the firm Size Natural logarithm of total assets
Previous period's
sur
p
lus status
Isloss
Previous year's net profit less than 0 is taken
as 1, otherwise 0
Degree of surplus
mana
g
ement
EM
Absolute value of manipulative accrued
p
rofit
Balance sheet ratio TDR
Ratio of total liabilities to total assets at the
end of the yea
r
Equity pledge Gqzz
The value is 1 if the enterprise has equity
p
led
g
e at the end of the
y
ear, otherwise it is 0
Type of accounting
firm
Big4
The accounting firm hired by the enterprise
belongs to the "Big Four" takes the value of
1, otherwise it takes 0
Industry Ind
According to the industry classification
standards promulgated by the Securities and
Futures Commission in 2001, manufacturing
industry is classified according to the second
level, while others are classified according to
the first level.
Yea
r
Yea
r
Set 2014 as the base, set 8 dummy variables
ICEMME 2022 - The International Conference on Economic Management and Model Engineering
200
3.2.4 Model Construction
To test the impact of large-scale goodwill impairment
on corporate audit fees, the following multiple
regression model is developed.
(1)
In the model AFee
it
is the audit fee of the ith
enterprise in year t, IG
it
is the size of goodwill
impairment of the ith enterprise in year t, Control
j,it
is
the control variable, and C is a constant term. Based
on the existing data and with the help of the statistical
analysis software stata, we run the above multiple
regression model. If the hypothesis holds, the
coefficient α should be significantly greater than 0.
4 EMPIRICAL ANALYSIS
4.1 Descriptive Statistics
Table 2 shows the descriptive statistics of the main
variables. It can be seen that the mean value of IG1 is
1.044 and the maximum value is 9.815, which
indicates that the scale of goodwill impairment is at a
high level and the scale of impairment varies greatly
among companies; the mean value of IG2 is 0.005,
which indicates that the scale of goodwill impairment
charged by listed companies is about 0.5% of the total
asset value on average; the mean value of AFee is
6.080 and the standard deviation is 0.280, which
indicates that the listed companies The mean value of
AFee is 6.080 with a standard deviation of 0.280,
indicating that the difference in audit fees is not very
large among listed companies, which may be related
to competition between supply and demand in the
audit market. The control variables Size, Big4, Isloss,
EM, and Big4 are reasonable and do not differ
significantly from the distribution of variables in
previous literature.
Table 2: Descriptive statistical analysis of the main variables.
Variables N Mean SD
Min
value
Max value
AFee 10319 6.080 0.280 5.301 7.885
IG1 10319 1.044 2.534 0 9.815
IG2 10319 0.005 0.093 0 8.642
Size 10319 9.715 0.531 7.503 12.437
Isloss 10319 0.160 0.366 0 1
EM 10319 0.081 0.158 0 6.464
Big4 10319 0.037 0.190 0 1
TDR 10319 0.460 0.668 0.014 63.971
Gqzz 10319 0.947 0.224 0 1
4.2 Impact of Goodwill Impairment on
Audit Fees
Table 3 shows the regression results of goodwill
impairment and audit fees, where columns (1) and (2)
show the regression results of IG1 and IG2 as
explanatory variables, respectively. As can be seen,
the coefficients of goodwill impairment size are
positive for both measures and pass the significance
test at the 1% level, indicating that goodwill
impairment size significantly increases audit pricing
and the hypothesis is verified. From the regression
results of the control variables, the coefficients of
Size, Big4, Isloss, EM, and TDR are significantly
positive, which is consistent with the results of
existing studies.
Table 3: Impact of the size of goodwill impairment on audit
fees.
Variables (1) IG1 (2) IG2
IG1 0.00703***
(0.000703)
itit
ititit
itititit
Big
GqzzTDREM
IslossSizeIGCAFee
4
Scale of Goodwill Impairment and Audit Charge
201
IG2 0.1055***
(0.0146)
Size 0.341*** 0.3465***
(
0.00384
)
(
0.00383
)
Isloss 0.0716*** 0.0732***
(
0.00501
)
(
0.00502
)
EM 0.0207* 0.0210*
(0.0114) (0.0114)
Big4 0.287*** 0.288***
(
0.00988
)
(
0.00991
)
TDR 0.0188*** 0.0182***
(
0.00266
)
(
0.00267
)
Gqzz 0.0028 0.0039
(0.00788) (0.00791)
Constant 2.7291*** 2.6770***
(
0.0378
)
(
0.0378
)
Industries Control Control
Yea
r
Control Control
Observations 10,319 10,319
R-square
d
0.5998 0.5971
Note: *** p<0.01, ** p<0.05, * p<0.1, standard errors in
parentheses.
4.3 Robustness Tests
4.3.1 Re-Measure the Variables
To determine the degree of influence of the main
explanatory variables on the explanatory variables,
different measures are used for the control variables,
replacing firm reputation from the top four (Big4) to
the top ten (Big10) and replacing firm size (Size) with
total owner's equity (Equity), and the findings are
unchanged after re-measuring the variables.
4.3.2 One Period Lag Treatment for All
Explanatory Variables
To mitigate possible reverse causality issues, all
explanatory variables are treated with a one-period
lag, which also tests the persistence of the effect of
premium M&A on audit pricing. The regression
results for the lagged treatments are all significant at
the 1% level, consistent with the main test.
4.3.3 Fixed Effects Model Regressions
Are Used
The study model may have the problem of omitted
variables, and in order to remove the effects of firm
characteristics that do not vary over time, a fixed-
effects model is used for regression testing, and the
regression results are consistent with the main test
regression results.
5 CONCLUSIONS
In this paper, we selected the data of A-share listed
enterprises from 2014-2021 and analyzed the impact
of goodwill impairment size on the audit fees of
enterprises using panel data. The empirical evidence
found that the larger the scale of goodwill impairment
of enterprises, the higher the audit fees. In this regard,
firstly, the professionalism of auditors should be
improved and listed companies should be carefully
examined for the existence of goodwill impairment
for surplus manipulation; Secondly, the supervision
of goodwill information disclosure should be
increased to reduce the motivation of companies to
use goodwill impairment for surplus management,
and a database of different industries should be
established to provide a basis for goodwill assessment
in M&A and restructuring of listed companies using
big data analysis.
The research conclusion of this paper has certain
practical significance. First, the professional quality
of audit institutions should be improved. Audit
institutions shall remain objective and rational,
maintain professional skepticism at all times, and
issue standard and reliable audit opinions. Certified
public accountants should carefully examine the
financial statements of listed companies, examine
whether listed companies use goodwill impairment to
manipulate earnings, prevent the company from
major misstatement risks and large goodwill
impairment events, and improve the reliability of
accounting information quality. Secondly, strengthen
the supervision of the disclosure of goodwill
information. There is still a large room for
improvement in the supervision of goodwill
information disclosure. Because the penalty cost is
too low, listed companies still have the incentive to
manipulate earnings management by goodwill
impairment. Therefore, our country should strengthen
the information disclosure supervision of goodwill. It
is suggested that relevant regulatory authorities
should introduce regulatory policies on goodwill
information disclosure, increase the content of
goodwill information disclosure of listed companies,
especially the information technology industry,
improve the information transparency of listed
companies and reduce the occurrence of violations.
Penalties will be increased for listed companies that
fail to make timely or inadequate disclosures. In
addition, databases of different industries can be
established and big data analysis can be used to
provide basis for goodwill assessment of listed
companies in mergers and acquisitions.
ICEMME 2022 - The International Conference on Economic Management and Model Engineering
202
In addition, the following deficiencies exist in this
paper. The article also does not analyze the role
mechanism of goodwill impairment scale affecting
audit fees deeply enough. In the future it and should
be studied in depth by combining the reasons of both
firms and enterprises. In addition, the ambiguity of
M&A goodwill from the time it arises, coupled with
the subsequent measurement using the method of
impairment, leads to more room for manipulation by
firms. In the future, it may be possible to initially
analyze the reasons for the firm's M&A and to
examine the changes in the firm's surplus before and
after the impairment of goodwill, which will help to
deeply understand the purpose of each relevant act.
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