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Journal of Accounting Research
Vol. 44 No. 2 May 2006
Printed in U.S.A.
Discussion of
Accounting Discretion in Fair Value
Estimates:
An Examination of SFAS 142
Goodwill Impairments
DANIEL A. BENS
ABSTRACT
Beatty and Weber examine an accounting choice that managers made upon
adoption of Statement of Financial Accounting Standards 142: whether to
record a goodwill asset impairment as a cumulative effect of an accounting
change at the time of adoption or delay the recognition of such an impairment
to the future (perhaps indefinitely) when they would be recorded as expenses
in earnings from continuing operations. The authors consider several factors
that might influence managements reporting of transition effects, including
contracting, equity market incentives, and regulatory forces. Participants at the
2005 Journal of Accounting Research Conference questioned whether such a
complex accounting decision can be captured with simple linear models and
noisy proxy variables, while also speculating upon whether the results would
generalize to other settings. In this discussion, I summarize Beatty and Webers
research, highlight its contribution to the accounting literature, and provide
a record of the main issues raised by the conference participants.
1. Summary
Beatty and Weber (henceforth, BW) examine the accounting choice that
a subsample of U.S. companies made upon the adoption of Statement of
University of Arizona. I thank Richard Leftwich (the editor) for his helpful comments.
289
C , University of Chicago on behalf of the Institute of Professional Accounting, 2006
Copyright
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D. A. BENS
Financial Accounting Standards 142 (SFAS 142) Goodwill and Other Intangible Assets. In this discussion, I briefly summarize the content of the paper,
state its contribution to the literature, and provide a record of the relevant
issues raised by participants of the 2005 Journal of Accounting Research
Conference.
BW pose the following question as their primary research motivation:
What factors affect managements decision to accelerate a goodwill impairment charge as an SFAS 142 below-the-line cumulative effect as opposed to
delaying the recognition of impairments into future above-the-line charges?
SFAS 142 changed the accounting for goodwill in three fundamental ways.
First, it eliminated the periodic amortization of these assets into expenses.
Second, it required that goodwill be assigned to a reporting unit for external reporting purposes that closely matched how management views the
corporations portfolio of businesses for internal purposes. Finally, it instituted a fair value test for determining goodwill impairments. Previously,
goodwill was treated similarly to other long-term assets for impairment testing: A comparison of undiscounted cash flows to the assets historical cost
was used. Upon adoption of the standard, firms were required to report any
reduction in the goodwill balance due to the stricter fair value test as a cumulative effect of an accounting change on the income statement, commonly
referred to as a below-the-line charge. Given that fair values are not readily
available for many of the reporting units to which goodwill balances were
assigned, managers enjoy a certain amount of discretion when applying this
standard. BW make several predictions regarding how managers use that
discretion during the transition period.
BW first identify a group of firms that are likely candidates for transition
impairment charges. These firms have goodwill outstanding at December
31, 2001, have a difference between the market and book values of their
equity that is less than their goodwill balance, and meet various other data
requirements for the cross-sectional tests.
Two different managerial choices are studied. First, using a probit model,
BW identify covariates of the decision to record a transition charge. Second,
using a censored regression, BW estimate how these same proxies are associated with the magnitude of the charge. These two models are each estimated
on two different samples, one limited in size due to lack of data availability
for some of the explanatory variables.
Three of the authors hypotheses focus on how contractual concerns
(debt, compensation, and employment) might affect the initial transition
charge. One hypothesis analyzes how the capitalization of earnings into stock
price (i.e., equity market incentives) might affect the transition charge. The
final hypothesis makes predictions regarding how regulatory constraints
might influence managements behavior.
The basis for BWs primary conclusions is reported in table 5 of the paper. There is weak evidence that the likelihood of taking a transition charge
is associated with less slack in a net worth debt covenant that includes the
effects of accounting changes. The evidence is somewhat stronger when
SFAS
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2. Contribution
Financial reporting rules require that managers make a significant number of subjective decisions when reporting accounting information to investors. As standard setters attempt (at least nominally) to move towards
principle-based standards, while embracing such concepts as fair value
accounting for assets and liabilities that are not actively traded, it seems
likely that the subjectivity in accounting reports will continue to rise.
The determinants of how these decisions are made by managers are still
not well understood, despite over three decades of academic research. This
ignorance is noted by Fields, Lys, and Vincent [2001, henceforth, FLV] in
their survey of the accounting choice literature. In particular, they claim that
one of the problems with the literature is that there have been few attempts
to take an integrated perspective (i.e., multiple goals) on accounting choice
(p. 258).
Most of the research surveyed by FLV analyzes a limited number of determinants of the accounting choice at hand, while ignoring many other
incentives that may be present. BW respond to FLVs call for more research that takes such an integrated approach, as they consider several
incentives that might affect a particular discretionary accounting choice.
In my opinion, this is a worthy goal, given the paucity of understanding
of the inputs to such decisions, and the ever increasing financial reporting
choices that managers are forced to make. I presume that many of the conference participants also believe that this is an interesting area of study, as
there was little discussion about why the authors chose to address this issue,
but rather, most of the comments focused on the research design and its
execution.
Some participants did question whether the result of this study would
generalize to other discretionary accounting choices. There was also some
discussion as to whether the paper reflected an overall critique of fair value
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D. A. BENS
3. Issues
I group my remaining comments, because they relate to two critiques
regarding research on accounting choice, in general, and this paper, in
particular. First, BW, like many other researchers, face a daunting task in
empirically modeling the complex nature of the strategic reporting decision.
Second, given the trade-off that must be made when sacrificing realism for
tractability in the model, any measurement error in, or misinterpretation
of, the proxy variables used significantly limits the conclusions that can be
drawn.
Conference participants noted that the simple empirical specifications
used by BW to test their hypotheses fail to capture the complex nature of
the transition impairment decision. For example, in complying with SFAS
142, management must first assign the goodwill balance to a reporting unit
prior to making an estimate of its fair value. As Watts [2003] notes, assigning
intangible assets to particular segments of the business is difficult, absent
a specific joint cost allocation model. Therefore, as noted by several participants, it would be interesting to study empirically how managers use
their discretion in this accounting choice. Unfortunately, as noted by the
presenter, the researcher faces the problem of developing an expectations
model of what is the proper allocation against which to study managements actual choice. Thus, BW are forced to ignore this important aspect
of the accounting choice decision.1
Another participant noted that accounting choices are often affected by
competitors actions, a force largely ignored in the BW model (though to
be fair, in sensitivity tests, BW use industry dummy variables as additional
controls). In addition, there are other players in this setting, such as auditors
and valuation consultants, that also behave strategically (and potentially
1 In their conclusion, BW state that they investigate the outcome of the managers goodwill
allocation and reporting unit decisions by examining the determinants of the SFAS 142 writeoff decisions. However, this is an indirect manner in which to study the allocation, and thus,
the paper does not shed much light on these accounting choices.
SFAS
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D. A. BENS
SFAS
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3 Whirlpools Securities and Exchange Commission filings may be accessed via their web site
at www.whirlpool.com.
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D. A. BENS
4. Conclusion
BW attack a problem that is of interest to accounting researchers: what
are the dominant forces that influence managements discretionary choices
when preparing financial reports? Although the choice set seems to be ever
expanding, as standard setters move away from objective measures such
as historical cost and towards subjective measures such as fair value, researchers still do not have a thorough understanding of how managers use
this discretion.
BW provide interesting insights by examining multiple forces that might
influence managements accounting choice, including contracting, equity
market incentives, and regulatory forces. While conference participants appreciated this multifaceted approach, they did not think it went far enough.
That is, accounting decisions can be quite complex, and a simple linear
framework may not capture many of the interesting subtleties involved.
Moreover, many of the proxy variables used in the BW framework were
difficult to interpret unambiguously. In addition, given an efficient stock
market and contracts that arise endogenously, it is unclear whether there
are any significant costs associated with managements strategic use of accounting discretion. That said, BWs results suggest that debt contracting
and regulatory forces appear to have an effect on accounting choice, and
this is a contribution to the literature. Future research should find these results useful, as it attempts to capture more of the complexity that academics
would like to see modeled.
REFERENCES
BEATTY, A., AND J. WEBER. Accounting Discretion in Fair Value Estimates: An Examination of
SFAS 142 Goodwill Impairments. Journal of Accounting Research 44 ( 2006), this issue.
BENS, D., AND W. HELTZER. The Information Content and Timeliness of Fair Value Accounting: Goodwill Write-offs Before, During and After Implementation of SFAS 142. Working
paper, University of Chicago, 2005.
BENS, D.; V. NAGAR; D. SKINNER; AND M. WONG. Employee Stock Options, EPS Dilution, and
Stock Repurchases. Journal of Accounting and Economics 36 (2003): 5190.
BRAV, A.; J. GRAHAM; C. HARVEY; AND R. MICHAELY. Payout Policy in the 21st Century. Journal
of Financial Economics 77 (2005): 483527.
FAMA, E., AND K. FRENCH. Disappearing Dividends: Changing Firm Characteristics or Lower
Propensity to Pay. Journal of Financial Economics 60 (2001): 343.
FIELDS, T.; T. LYS; AND L. VINCENT. Empirical Research on Accounting Choice. Journal of
Accounting & Economics 31 (2001): 255307.
WATTS, R. Conservatism in Accounting Part I: Explanations and Implications. Accounting
Horizons 17 (2003): 20721.