Big Bath Earnings Management: The Case Of Goodwill Impairment Under SFAS No. 142

The big bath theory of earnings management suggests that firms experiencing low earnings in a given year may take discretionary write downs to reduce even further the current period’s earnings.  The notion is that the company and its management will not be punished proportionately more for the big hit it takes to its already depressed earnings.  This “clearing of the decks” makes it easier to generate higher profits in later years.  SFAS No. 142, with its new requirement to test goodwill annually for impairment, provided a unique opportunity to test this big bath theory.  Examining Fortune 100 companies, this study presents compelling evidence that the big bath theory is more than just a theory but is instead a practiced method of managing earnings.

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Goodwill Impairment: A New Window For Earnings Management?

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v8i2.669 ◽

2010 ◽

Vol 8 (2) ◽

Cited By ~ 1

Author(s):

Yousef Jahmani ◽

William A. Dowling ◽

Paul D. Torres

Keyword(s):

Earnings Management ◽

Balance Sheet ◽

Accounting Information ◽

Accounting Standards ◽

Financial Accounting ◽

Financial Accounting Standards Board ◽

Font Size ◽

Rates Of Return ◽

Public Companies ◽

Goodwill Impairment

The Financial Accounting Standards Board promulgated standard No. 142 in an attempt to improve the understandability of accounting information.  This new rule eliminated the practice of automatically amortizing goodwill.  No. 142 requires public companies to test goodwill for possible impairment at least annually.  An unintended consequence of this new standard is the opportunity for companies to use it in earnings management.  To test the possibility that the rule is being used for this purpose, a sample of companies was chosen, all of which had amounts of goodwill on their balance sheet during the 2003-2005 interval.  The results reveal that the number of companies experiencing losses or low rates of return on total assets who actually impaired goodwill was statistically insignificant during the period under consideration.  Thus, the results strongly suggest that companies are using No. 142 in an attempt to manage the volatility of earnings.

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Using Goodwill Impairment To Effect Earnings Management During SFAS No. 142s Year Of Adoption And Later

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v5i1.2510 ◽

2011 ◽

Vol 5 (1) ◽

Cited By ~ 2

Author(s):

Charles E. Jordan ◽

Stanley J. Clark ◽

Carol E. Vann

Keyword(s):

Earnings Management ◽

Line Treatment ◽

Goodwill Impairment ◽

Big Bath ◽

Number Of Firms

Prior research (Bens and Heltzer, 2004) shows that the market penalizes firms less for reporting goodwill write-downs below-the-line than it does for presenting them above-the-line. Only in 2002, the year SFAS No. 142 became effective, did goodwill impairments enjoy below-the-line treatment. The current research provides evidence that firms “cherry picked” this year to recognize large impairment losses, thus removing much of the burden from future years when these losses otherwise would have been reported above-the-line. The study also indicates that, even though the number of firms taking goodwill write-offs declined subsequent to 2002, those entities that did so seemed to be taking these discretionary hits because earnings were already depressed in the current year. As such, the big bath earnings management observed in the year of adoption in previous studies (Jordan and Clark, 2004 and 2005) appears to continue even though these impairment losses no longer receive favorable below-the-line treatment.

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CEO Turnover, Earnings Management, and Big Bath

SSRN Electronic Journal ◽

10.2139/ssrn.2165123 ◽

2012 ◽

Cited By ~ 1

Author(s):

Chia-Feng Yu

Keyword(s):

Earnings Management ◽

Ceo Turnover ◽

Big Bath

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Do Canadian Companies Employ Big Bath Accounting When Recording Goodwill Impairment?

International Journal of Economics and Finance ◽

10.5539/ijef.v7n9p159 ◽

2015 ◽

Vol 7 (9) ◽

Cited By ~ 2

Author(s):

Charles E. Jordan ◽

Stanley J. Clark

Keyword(s):

Goodwill Impairment ◽

Big Bath

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Earnings management and goodwill impairment

Journal of Intellectual Capital ◽

10.1108/jic-09-2015-0081 ◽

2016 ◽

Vol 17 (1) ◽

pp. 120-147 ◽

Cited By ~ 5

Author(s):

Giuseppe Davide Caruso ◽

Elisa Rita Ferrari ◽

Vincenzo Pisano

Keyword(s):

Earnings Management ◽

Design Methodology ◽

Income Smoothing ◽

Financial Accounting ◽

Current Debate ◽

Managerial Behavior ◽

Content Type ◽

Listed Firms ◽

Goodwill Impairment ◽

Research Questions

Purpose – The purpose of this paper is to understand whether managerial behavior in impairing goodwill arising from M & As has changed after the adoption of IAS/IFRS, searching for evidences of earnings management (EM) practices. Thus, our goal is to provide a response to the following research questions. Are goodwill impairments used by listed firms’ managers to manipulate earnings? If so, what kind of EM practice is mostly used? Design/methodology/approach – In this paper the authors tested the following hypothesis: H1. In the year of the deal’s closure and in the following four years, the management detects impairment of goodwill in difformity with the previous Italian regulations and related accounting practices. Moreover, the authors tried to determine, for each considered firms, potential symptoms of typical DEM practices widely debated in the financial accounting literature (income smoothing, income minimization, income minimization, or big bath accounting). Findings – Our analysis does not prove evidence of certain EM practices, but it highlights very clearly that, after the adoption of IAS/IFRS, managers’ behavior has deeply changed. Moreover, the analysis shows that there is no univocal choice in favor of a specific EM practice and that every firm pursues its own “strategy.” Originality/value – Considering the importance of the topic from both the perspectives of managerial (with regard to M & As valuation processes) and financial accounting (with regard to intangibles valuation fulfilled by applying the impairment test instead of the amortization), this work aims to provide a multi-dimensional contribution to the current debate.

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Role Of Underwriters In Restraining Earnings Management In Initial Public Offerings

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v28i4.7054 ◽

2012 ◽

Vol 28 (4) ◽

pp. 709 ◽

Cited By ~ 6

Author(s):

Hei Wai Lee ◽

Yan Alice Xie ◽

Jian Zhou

Keyword(s):

Earnings Management ◽

Initial Public Offerings ◽

The Internet ◽

Venture Capitalists ◽

Font Size ◽

Going Public ◽

Public Offerings ◽

Investment Bankers ◽

Sarbanes Oxley

We investigate the relationship between underwriter reputation and earnings management of IPO firms over the period of 1991-2005. We find that IPO firms engage in less earnings management if they are underwritten by prestigious investment bankers. Furthermore, the role of prestigious underwriters in restraining earnings management of IPO issuers do not change during the Internet Bubble period or after the passage of the Sarbanes-Oxley Act (SOX). The findings support the certification role of underwriters in the IPO process. We also document that firms going public in the post-SOX period engage in less earnings management compared to firms going public in the pre-SOX period. Further findings suggest that the changing objectives of venture capitalists may explain the reduction in the level of earnings management of IPO firms following the passage of SOX.

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Goodwill And Goodwill Write-Downs: Their Effects On Earnings Quality For 2008 And 2009

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v7i11.2351 ◽

2011 ◽

Vol 7 (11) ◽

Author(s):

Don E. Giacomino ◽

Michael D. Akers

Keyword(s):

Earnings Management ◽

Earnings Quality ◽

Pension Plan ◽

Expected Returns ◽

Balance Sheets ◽

Big Bath

This paper examines goodwill on corporate balance sheets. Specifically, the paper measures the extent to which goodwill exists on corporate balance sheets and the degree of goodwill write-downs that have occurred recently. We report on our study and a study by Intangible Business, which show that many firms carry substantial amounts of goodwill on their 2008 balance sheets. Thus, because of the recent downturn in the economy and the markets, the potential for big bath earnings management for 2008 and 2009 exists. In addition, because of reductions in expected returns on pension plan assets, many firms are likely to record much higher pension expenses. We expect that the combination of goodwill impairments and increased pension expense will have significant effects on both the amount and the quality of earnings for 2008 and, possibly, 2009.

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Public Accountants’ Perceptions Of The Acceptability Of Earnings Management Practices Through The Employment Of GAAP In The Post-Sox Period

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v26i1.277 ◽

2010 ◽

Vol 26 (1) ◽

Cited By ~ 1

Author(s):

John E. McEnroe

Keyword(s):

Earnings Management ◽

Management Practices ◽

Financial Statements ◽

Securities And Exchange Commission ◽

Font Size ◽

Generally Accepted Accounting Principles ◽

Sarbanes Oxley ◽

Accounting Scandals ◽

Audit Opinions ◽

Certification Requirements

Over fifteen years ago, Martens and McEnroe (1992) conducted a behavioral study involving earnings management through the use of Generally Accepted Accounting Principles (GAAP). Their findings indicated that auditors issued unqualified audit opinions on those financial statements and perceived little risk to litigation as a result. A decade later they conducted a similar study (Martens and McEnroe 2002) with the expectation that increased attention to earnings management by then chairman of the Securities and Exchange Commission (SEC), Arthur Levitt, would reduce auditors’ perceptions that the letter of GAAP is in itself an aegis or “safe harbor” against litigation. Although the authors found that auditors had become more conservative, they still issued unqualified opinions on financial statements in which transactions were reported in their form rather than their substance. Given the accounting scandals of Enron and WorldCom, among others, and the enactment of the Sarbanes-Oxley Act (SOX) in 2002, especially with its officers’ certification requirements, it was posited that auditors would exhibit a much more conservative approach than in either of the two previous studies. The results indicate that although auditors are more conservative than in the 1992 study, they still allow clients to engage in earnings management practices through the use of GAAP by issuing unqualified audit opinions on their financial statements.

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The Influence of Executive Compensation Gap on Earnings Management from the Perspective of Media Supervision: Evidence from China

Discrete Dynamics in Nature and Society ◽

10.1155/2021/3203759 ◽

2021 ◽

Vol 2021 ◽

pp. 1-10

Author(s):

Ye Wang ◽

Fusheng Wang ◽

Shiyu Liu

Keyword(s):

High Pressure ◽

Earnings Management ◽

Executive Compensation ◽

Financial Indicators ◽

Management Behavior ◽

Media Attention ◽

Current Period ◽

Media Supervision ◽

Compensation Gap ◽

Accrued Earnings

To pursue higher compensation, the agent’s earnings management behavior may damage the principal’s interests. Can managers whose compensation reaches the expected level seek benefits for the company through earnings management? This study takes China’s A-share listed companies from 2014 to 2018 as samples. The conclusions show that managers with higher compensation levels will carry out earnings management in favor of the company while taking their own interests into consideration. For companies with stronger profitability, the higher the managers’ compensation is, the more they are inclined to reduce accrued earnings in the current period to further reduce taxes and fees. For companies with weaker profitability, managers with higher compensation tend to choose to increase real earnings to further optimize financial indicators. It has been found through further research that high pressure generated by media attention can make well-paid executives restrain the above earnings management behavior, which serves as an effective method to protect investors’ rights and interests.

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Firm Valuation, Market Responses, And Accounting Conservatism

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v29i3.7781 ◽

2013 ◽

Vol 29 (3) ◽

pp. 793

Author(s):

Karin A. Petruska ◽

Gulraze Wakil

Keyword(s):

Stock Returns ◽

Value Relevance ◽

Firm Valuation ◽

Financial Information ◽

Accounting Conservatism ◽

Compelling Evidence ◽

Font Size ◽

Market Responses ◽

Over Time

This study examines whether the components of accounting conservatism as described in Watts (2003a): contracting, litigation, regulation, and taxation, provide insight on the value relevance of financial information. During the years 1993 through 2009, we explore whether these four factors are value relevant in capturing information in contemporaneous stock returns and prices and whether the trends in value relevance for these drivers vary across time. Specifically, our study aids in helping to reconcile the competing results of Balachandran and Mohanram (2011), who state that there is no compelling evidence that firms with higher levels of accounting conservatism exhibit decreasing levels of value relevance, and Lev and Zarowin (1999), who suggest that accounting conservatism is a factor causing a decline in the usefulness of financial information over time. Our results provide evidence that the level of contracting, litigation, and regulation are associated with returns and prices and their value relevance has not decreased over time, findings which differ from Lev and Zarowin (1999), and support Balachandran and Mohanram (2011), such that the expectation of these drivers are associated with value relevance. In addition, we find less consistent evidence that the taxation explanation of accounting conservatism is associated with value relevance.

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