Auditor
’s Perceptions of
Earnings Management in
Goodwill Accounting
A qualitative study based in
Luxembourg and Sweden
Edwin Davis, Amélie VachetDepartment of Business Administration Master's Program in Accounting
Acknowledgments
First, we would like to thank our supervisor Dennis Sundvik for the great help, the serious follow-up and the constructive criticisms he provided us during our whole writing process. Both his knowledge and great involvement were definitely a valuable asset for us conducting
this master thesis.
We would also like to thank all the auditors who accepted to participate in our interviews and provided us with interesting insights, particularly in this period of the year which is very
intense for auditors and in this special context of COVID-19. Without them, this degree project would not have been feasible.
Lastly, we would like to thank our family and friends who gave us their support and advice during the whole project.
Umeå May 25, 2020
Abstract
In 2005, international accounting standards changed the treatment of goodwill, by replacing annual amortisation with impairment tests of goodwill. This has created a heated debate in accounting research. Scholars are split whether the switch to impairment tests have increased or decreased both accounting and audit quality. The subjective nature of impairment tests, deriving from being based on fair values and estimations have resulted in a rise of studies covering its potential shortcomings.
Main issues with impairment tests have been related to its possible impact on increase in earnings management (EM) engagement, dependence on estimations and discretionary problems. There are many surrounding questions regarding goodwill and EM, along with the current goodwill rules being subject to criticism. This study aims to investigate further the relationship between goodwill and EM, as well as exploring the perception auditors have regarding that topic and the related accounting standards. Moreover, we aim to get a better understanding about the role the auditor possesses in both enabling and preventing EM activities in private firms and public firms.
List of abbreviations
AEM: Accrual-based Earnings Management AQI: Audit Quality Indicators
CEO: Chief Executive Officer EM: Earnings Management EPS: Earnings per share
FASB: Financial Accounting Standards Board FV: Fair value
IAASB: International Auditing and Assurance Standards Board IAS: International Accounting Standards
IASB: International Accounting Standard Board IFRS: International Financial Reporting Standards ISA: International Standards on Auditing
ISQC: International Standards on Quality Control ITC: Invitation To Comment
PCAOB: Public Company Accounting Oversight Board REM: Real Earnings Management
ROA: Return on assets
SFAS: Statement of Financial Accounting Standards SMEs: Small and Medium-sized Enterprises
Table of contents
1.0 Introduction ... 1
1.1 Subject choice, background and relevance ... 1
1.2 Research gaps ... 2 1.3 Purpose... 2 1.4 Research question ... 2 1.5 Limitations ... 2 1.6 Structure ... 2 2.0 Scientific Method ... 3 2.1 Research philosophy ... 3 2.1.1 Ontology ... 3 2.1.2 Epistemology ... 4 2.1.3 Axiology ... 4 2.2 Research approach ... 4 2.3 Research design... 5 2.4 Preconceptions ... 6 2.5 Literature search ... 6
2.6 Choice of theories and concepts... 7
2.7 Ethical considerations ... 8
3.0 Theoretical framework ... 9
3.1 Earnings management ... 9
3.1.1 Definition ... 9
3.1.2 Motivations ... 9
3.1.3 EM and CEO’s tenure... 9
3.1.4 Accrual and Real EM ... 10
3.1.5 Accounting standards and EM ... 10
3.1.6 Consequences of EM ... 11 3.1.7 Mitigating factors of EM ... 11 3.2 Goodwill ... 12 3.2.1 Assets ... 12 3.2.2 Definition of goodwill ... 12 3.2.3 Recognition of goodwill ... 13
3.2.4 Amortisation and impairment of goodwill ... 14
3.2.5 Debates around the goodwill standards ... 15
3.3 Audit ... 16
3.3.1 Definition and purpose ... 16
3.3.2 Audit process ... 16
3.3.3 Audit and quality ... 17
3.3.4 Auditing standards ... 18
4.0 Literature review ... 19
4.1 Role of goodwill in EM... 19
4.2 Opportunistic behaviour and role of compensation ... 19
4.3 Time factor and accounting quality ... 20
4.4 Discretion and Verifiability problem in goodwill impairment testing and FV ... 20
4.5 Audit quality and Goodwill ... 21
4.6 EM in private vs. public firms ... 21
5.0 Research method ... 23
5.1 Data collection ... 23
5.2 Qualitative data collection and semi-structured interviews ... 23
5.2.1 Semi-structured interviews ... 23
5.2.2 Qualitative sampling technique ... 24
5.3 Interview guide elaboration ... 25
5.3.1 The qualitative interview experience ... 25
5.3.2 Literature review’s gaps and interests ... 25
5.3.3 Interview guide ... 26
5.4 Conducting the interviews ... 26
5.5 Qualitative analysis ... 27
5.5.1 Key elements ... 27
5.5.2 General analytical procedure ... 28
5.5.3 Coding ... 28
6.0 Empirical Findings... 29
6.1 Overview of the findings ... 29
6.2 Goodwill treatment preference... 31
6.2.1 Beneficial aspects of impairment tests of goodwill ... 31
6.2.2 Negative aspects of impairment tests of goodwill ... 31
6.2.3 Impact on audit quality ... 32
6.2.4 Goodwill importance in private firms and public firms ... 32
6.3 Relationship between goodwill and EM ... 33
6.3.1 EM main drivers ... 33
6.3.3 EM barriers and prevention ... 34
6.4 Audit detection of EM ... 34
6.4.1 Detection of EM in goodwill ... 34
6.4.2 Discretion and verifiability problems under Impairment Testing ... 34
6.4.3 Opinion about the current accounting standards ... 35
7.0 Qualitative Analysis ... 36
7.1 Impairment testing vs. Amortisation of goodwill ... 36
7.1.1 The impact of goodwill impairment testing on accounting quality ... 36
7.1.2 Goodwill standards in publicly listed firms vs private firms... 36
7.2 EM in general and related to goodwill ... 37
7.2.1 EM drivers ... 37
7.2.2 Introduction of goodwill impairment testing goodwill and EM ... 38
7.3 Audit quality and verifiability problem ... 38
7.3.1 Impact of the impairment testing introduction on audit quality ... 38
7.3.2 Verifiability problem in goodwill impairment testing ... 39
7.3.3 Detection of EM and EM barriers ... 39
8.0 Conclusion ... 41
8.1 General conclusion ... 41
8.2 Theoretical and practical contributions ... 42
8.3 Limitations and suggestion for further research ... 42
8.4 Qualitative quality/truth criteria ... 43
Figures
Figure 1 - Simplified overview of the EM process ... 11
Figure 2 - Representation of goodwill ... 13
Figure 3 - Simplified overview of the audit process ... 17
Figure 4 - Interview guide... 26
Figure 5 - Manager's main ideas ... 29
Figure 6 - Senior's main ideas ... 30
Figure 7 - Junior's main ideas ... 30
1
1.0 Introduction
1.1 Subject choice, background and relevance
When a company acquires another business, the excess of price over the fair value of net identifiable assets is defined as goodwill (Rashty, 2018, p. 48). In recent times, goodwill has become a significant source of debate after both the International Accounting Standard Board (IASB) in 2005, and the Financial Accounting Standards Board (FASB) changed the accounting rules for goodwill. The new accounting standards (IFRS 3 and SFAS 142) meant that goodwill no longer is subject to amortisation (Van Hulzen et al., 2011, p. 93; Ramanna & Watts, 2012, p. 750). Instead, goodwill shall be annually tested for impairment (Pajunen & Saastamoinen, 2013, p. 245). This follows the IASB view of transitioning from historical cost measures to fair value measures (Hamberg et al., 2011, p. 264). The reason for introducing impairment tests for goodwill is due to the difficulties in not being able to predict the useful life of goodwill, which is required in amortization (Van Hulzen et al., 2011, p. 94). Another motivation to favour fair value is said to be that amortisation of goodwill can lead to arbitrary accounting (Van Hulzen et al., 2011, p. 114) and improve the decision usefulness of accounting information (Hamberg et al., 2011, p. 263). The impairment of goodwill seems even more relevant in the current context of the COVID-19 pandemic situation. Indeed, according to KPMG (2020), goodwill must also be tested between annual tests in case of any triggering event, such as this exceptional situation that is both at the origin of substantial declines in market capitalization and negatively impacting companies’ financial performance. Therefore, “As part of the overall analysis of the financial reporting impacts of COVID-19, companies
may need to evaluate the recoverability of goodwill, intangible assets, property, plant and equipment, and lease right-of-use (ROU) assets” (KPMG, 2020, p.1). In other words, in
addition to the annual impairment test, certain entities may need to perform an extra impairment assessment of assets, including goodwill (Deloitte, 2020).
However, the debate whether moving away from goodwill amortisation was an incorrect decision, has resulted in a rise of studies covering this topic. This derives from the shortcomings which can be related to impairment testing; it potentially increases top-management engagement in earnings management and opportunistic behaviour (Hamberg et al., 2011, p. 285). Impairment tests are dependent on estimates of managers which may place a question mark surrounding the validity of an impairment test, thus making the managers discretion an important factor in this process (Li & Sloan, 2017, p. 965). Not being able to objectively define the value of goodwill after initial recognition could cause problems from an accounting perspective (Korošec et al., 2016). In addition, managers’ bias is shown to have opportunistic effects on financial reporting (Li & Sloan, 2017, p. 997) which both questions the reliability of the accounting information and could increase the presence of earnings management (EM) within a company. Wallace et al. (2004, p.2) define the concept of EM as “the use of flexible
accounting principles that allow managers to influence reported earnings, thereby causing reported income to be larger or smaller that it would otherwise be”. As the current standards
regarding goodwill are still highly questioned, the FASB issued in 2019 an invitation to comment (ITC) in order to assess the current situation, and maybe even question a return to amortisation (Betancourt & Irving, 2019).
2
examination of the financial records, internal controls and financial reports (i.e., financial statements) of an organisation to assure that the financial reporting is done in a fair and accurate way”.
1.2 Research gaps
Recent studies have focused on the impact of the transition to goodwill impairment tests mainly within the US GAAP (See Hamberg et al., 2011; Ramanna, 2012; Beatty, 2006). Scarce research exists towards this topic in countries using IFRS (Knauer and Wöhrmann, 2016, p. 245). Apart from Pajunen & Saastamoinen (2013), few studies have analysed the audits role in validating impairment tests. Furthermore, those studies were all published before the new update of 2017 about goodwill regulation and are all mainly quantitative studies. To research and investigate the role of audit in the impairment of goodwill in an EM perspective could decrease the research gap within this topic, and it can help to decrease the problem of using goodwill in an opportunistic behaviour. Also, it contributes to get some feedback about the current standards on goodwill, and may help the accounting and auditing boards in the next updates they will make in a foreseeable future.
1.3 Purpose
The aim of this study is to further investigate the extent of EM derived from goodwill and what role the audit possesses in preventing or enabling such activities. To do so, we will conduct a qualitative research by interviewing auditors based in both Sweden and Luxembourg and auditing mainly publicly listed companies but also private ones. This way, we aim to find out what auditors think about the introduction of impairment testing of goodwill and the related impacts on EM, having consequences on both accounting and audit quality.
1.4 Research question
Therefore, our aim is to answer the following research question: how do auditors assess the risk of earnings management in goodwill and the related accounting standards, in both private and publicly listed companies?
1.5 Limitations
The main limitation of this study is its rather small sample of professionals in the audit industry from both Luxembourg and Sweden, and therefore the conclusions we obtained cannot be applied on a bigger population. However, it gives to the topics of EM and Goodwill new insights that aim to be further explored. Please refer to the part 8.3 of this study for more details.
1.6 Structure
3 the sample selection. We will then analyse the interviews and findings in order to find new relevant insights and draw our conclusions from it.
2.0 Scientific Method
In this chapter, we will present and discuss our philosophical point of view which constitutes the base of our study and how we conducted the latter, particularly regarding our ontological and epistemological beliefs. We explain those theories and the choices we made to conduct our study.
2.1 Research philosophy
2.1.1 Ontology
Ontology raises the concern of the nature of reality, including the assumptions and perceptions the researchers make about it, and the extent to which its aspects can be considered as valid knowledge or not, in the different research fields (Saunders et al., 2009, p.110). Saunders et al. (2009, p.110) point out two main aspects of ontology: objectivism, which supports the idea that social entities exist independent of the related social actors, meaning that only one reality exists, and subjectivism, which supports the idea that social phenomena are the result from both social actors’ perceptions and actions, meaning that several different realities may exist. The former is associated to the positivist philosophy, that is the study of social phenomena the same way as with the natural ones, with an independent researcher focusing on observable facts in a value-free way (Saunders et al., 2009, pp.113-114). The latter is associated to the interpretivist philosophy “that is necessary to explore the subjective meanings motivating the actions of
social actors in order for the researcher to be able to understand these actions” (Saunders et
al., 2009, p.111).
4 accounting and EM, are also very likely to be an active social actor in the constructed reality auditors have. Indeed, even if accounting and auditing rules tend to be harmonised nowadays, there are still differences that make several different realities in the world about that topic. In our study, we will mostly interview auditors from Sweden and from Luxembourg, in order to compare the different realities they can have. This way, the reality is socially constructed by the auditors themselves, but also by the companies, managers, accountants, accounting and auditing boards, governments, which makes multiple realities to be understood.
2.1.2 Epistemology
Epistemology, linked to ontology and the nature or reality, is about what is considered as acceptable knowledge in a particular field of study (Saunders et al., 2009, p.112). A positivist approach will be very likely to consider as acceptable knowledge what is observable in the social reality and then to generalise the results of the study (Saunders et al., 2009, p.113). On the other hand, an interpretivism approach will consider as acceptable knowledge subjective meanings and social phenomena, and will focus on the details of a situation in order to try to find out what is behind (Saunders et al., 2009, p.119). As interpretivists, we will conduct qualitative interviews and try to focus on the details of the auditor’s answers in order to find out what motivates them to think one way or another and why they assess the risk of EM in goodwill the way they do.
2.1.3 Axiology
Axiology studies the roles of our values in the context of research (Saunders et al., 2009, p.116). We, as humans, are guided by our values, and it also applies for our judgements and actions when conducting a research process (Saunders et al., 2009, p.116). As we chose the interpretivism approach and the topic of EM in goodwill, it already shows a part of our values in conducting this research. We are aware that, as researchers of this study, we are part of it and cannot be separated from this study, which thus makes the study inevitably somehow subjective.
2.2 Research approach
Two main research approaches can be used when conducting a research: deductive or inductive (Saunders et al., 2009, pp.124-126). The deductive approach will develop a theory with hypothesis and then test it by designing its own research strategy. This approach is in general associated to the positivist approach and tend to be more a scientific research commonly used in natural sciences. The final results generally allow a generalisation of the findings to the population of the tested samples. The second approach, the inductive one, which is in general associated to the interpretivism approach, will first collect data and then analyse it in order to develop and formulate a theory. This approach gives some place and interest to alternative explanations when studying a topic and is highly concerned with the context surrounding the topic and its phenomena. This explains why an inductive approach will favour small samples instead of large ones. When conducting a research, it is possible to combine both quantitative and qualitative approaches. Indeed, an abductive approach, compared to the previous ones, will be subject to more dynamic interaction between data and theory (Gupta & Awasthy, 2015).
5 important issues and concerns and develop interesting questions for our interviews, considering the theories that have already been tested. We will then collect data when interviewing auditors about the risk of EM in goodwill and analyse it. Through this qualitative study, we aim to improve the validity of the prior studies, but also to get a related but different facet of EM in goodwill and extend the scope of study by finding new insights. Based on the previous studies, we do know that EM may exists when it comes to goodwill and therefore that a risk exists. However, we wonder how auditors assess this risk and, more particularly, if they make any difference in it when auditing either private or publicly listed companies. We aim to consider as many explanations as possible from the interviewees.
2.3 Research design
The research design is the general and overall plan established in order to answer the research question(s) of a study by setting up clear objectives (Saunders et al., 2009, pp.136-137). Exploratory studies aim to find out what is happening in order to find new insights about a topic or a problem. (Saunders et al., 2009, p.139). The three principal ways of conducting such a research are: a search of the literature, interviewing “experts” in the subject and conducting focus group interviews (Saunders et al., 2009, p. 140). Depend on the collected data, it is possible to change the direction of the research. Descriptive studies are about getting a clear picture of research topic/phenomena before collecting data (Saunders et al., 2009, p.140). Explanatory studies establish causal relationships between variables of a situation or a problem, and can even establish correlation between those variables (Saunders et al., 2009, p.140).
Creswell (2014) defines research designs as “types of inquiry within qualitative, quantitative,
and mixed methods approaches that provide specific direction for procedures in a research study”. Adams et al. (2014) point out two main domains of research: quantitative research or
qualitative research. The first one is adequate with the positivist approach and is characterised by its strict standards, quantitative measurement and statistical analysis. The qualitative one aims to explore social relations and to describe what the respondents answer and believe. The core characteristics of qualitative research are: natural setting, researcher as key instrument, multiple sources of data, participants’ meanings, emergent design, reflexivity, holistic account (Creswell, 2014). Saunders et al. (2009, p. 318) define interview as a discussion between at least two people aiming to help the researcher gathering reliable and valid data in relation to the objectives of the study, in order to either answer or formulate the research questions. Several types of interview fit different objectives, purposes and strategies and therefore can be structured, semi-structured, in-depth, standardised, non-standardised, participant, informant, group interviews (Saunders et al., 2009, p. 320). In this part, we will focus on the semi-structured type and explain this choice in a second time. Semi-semi-structured interviews are characterised by beforehand selected themes and questions to cover that may vary depending on both the context and respondent specificities, which can also result in additional spontaneous questions (Saunders et al., 2009, pp. 320-321).
6 conversations and will be semi-structured. Indeed, we will prepare some general questions beforehand but we expect each interview to be singular due to the fact that each auditor will have his own specific background, professional experience, personality and professional context. The interviews will contain opened questions intended to elicit views and opinions from the participants. After executing the interviews, we will audiotape it and transcribe it in order to analyse the answers.
2.4 Preconceptions
When conducting a research, the researcher must be aware of his own preconceptions and more particularly about the ones he has regarding the studied topic (Saunders et al., 2009, p.151). According to Solbue (2011), the research is influenced by the unconscious attitudes of the researcher, who can through a reflexive process on himself find what are his own hidden preconceptions in relation to the subjects and the context of the research. The author highlights the fact that it is important to be aware of those preconceptions when one position himself within the context of the study but also during the data analysis part of the research, in order to interpret correctly its results. For Gaudet & Robert (2018), it is also important to be aware of his own preconceptions of social phenomena and to not reproduce the preconceptions of the interviewees.
Therefore, we first need to reflect on ourselves in order to be aware of our own preconceptions regarding our topic. As business students at Umeå University, we both studied Accounting and Finance and got introduced to the earnings management and goodwill topics. Also, we both followed a full module concerning Auditing. It means that we already had information about those topics before starting this research project. However, we did not go that far in terms of detailed information regarding those topics in the past, and we still learn new things about it when going through academic articles and books. Those preconceptions mostly helped us choosing our topic. Also, one of us has some short experience in auditing after doing internships in the framework of his/her educational requirements. That experience is very likely to help us gaining a better understanding of the interviewees’ answers and opinions. On the other hand, it will be possible and interesting to compare our respective points of view on the topic, meaning, with and without prior audit experience. This way, our aim is to be the less bias as possible.
2.5 Literature search
Collis and Hussey (2014, p. 76) define a literature search as a “systematic process with a view
to identifying the existing body of knowledge on a particular topic”. Indeed, literature search
aims to collect a satisfying quantity of literature items, secondary data such as academic articles, in order to read them and thus have a deeper knowledge about the subject and the methodologies used. Knowing what has been done before is an essential part of a research project in order to identify the related main issues, gaps and deficiencies to focus on (Collis & Hussey, 2014, pp. 76-77).
7 related to Goodwill from the start, as well as the current debates on the Goodwill standards. We found interesting to put those two concepts together. We found a lot of articles having as a main subject EM in goodwill. However, only a small proportion of it included the auditor’s point of view, which is, according to us, a major concern when raising the issue of EM. This way, to find relevant articles, we used keywords such as Goodwill, EM, Audit. We used it “independently” in order to constitute a comprehensive theoretical background and introduce a general and global vision of each concept. In our literature review part, we tried to combine those keywords in order to find articles that illustrate well our topic of EM in goodwill related to the auditor’s point of view: “EM and audit”, “EM in goodwill”, “goodwill, audit and EM”. Moreover, our thesis supervisor kindly provided us with recent academic articles in direct relation with our topic, which was highly appreciable.
To follow a proper research’s structure in the scope of this master thesis, we mainly used the keywords “research methodology” in our databases, in order to find books and academic articles providing research guidelines either for business students or managers. This allowed us to gain a better understanding of how to conduct our research, and more specifically of how to conduct a qualitative research, how to collect data and analyse it. We also looked for former master thesis in order to better understand concretely the structure of it and how the whole work should be conducted.
2.6 Choice of theories and concepts
Goodwill standards are regularly updated by the accounting and auditing boards, such as the IAASB, for which it seems difficult to agree on a definitive standard. We find the concept of goodwill very interesting, singular and up-to-date, and this is why we chose this as our first concept. The second most relevant concept we chose is EM, due to the fact it is still a major concern in today’s businesses. In our theoretical framework, we explain why it is such an issue by detailing what the agency theory (principal-agent problem) is and what can be the consequences. In EM, goodwill is a hot topic due to its rules not always very clear and strict. It gives managers potential opportunities to manage numbers. Moreover, we find it even more interesting to put goodwill in relation to EM, due to its related relative subjectivity. Finally, after reviewing the literature about EM and goodwill, we identified a main gap that is the point of view of people assessing EM in goodwill. Indeed, most of the people were analysts, and auditors were not very often included even though EM and audit are closely related. As explained in our theoretical framework, audit somehow exists because of EM. Also, audit is a familiar concept for us, as accounting students, and with prior professional experiences related to this domain. Also, audit is based on the accounting rules and standards, and therefore is highly concerned with the goodwill hot topic. This way, we naturally decided to choose audit as our third and final concept.
When going through articles gathering those three concepts, we found an interesting Finnish quantitative study from 2013, Do auditors perceive that there exists earnings management in
goodwill accounting under IFRS?, written by Pajunen and Saastamoinen. This quantitative
8
2.7 Ethical considerations
Over the past decade, the ethics of research practice has been an important topic showing growing concerns (Saunders et al., 2009, p. 168). Collis & Hussey (2014, p. 30) define ethics as “the moral values or principles that form the basis of a code of conduct”. Ethics in the context of research is therefore concerned with how the whole research is conducted, from the start to the presentation of the findings. Principally, during the whole study, no harm should be caused to the participants, their dignity has to be respected, they should be informed about everything concerning the study before any participation and the researchers have to protect their anonymity and their confidentiality (Collis & Hussey, 2014, pp. 31-33). In other words, participants must show a voluntary participation and need to have the assurance that they will not be named in the research and that the information provided won’t be traceable to them (Collis & Hussey, 2014, p. 32).
In our study, we did not conduct any interview that could be somehow related to harming the participants, their company or their future opportunities. We kept private the name of the auditors, as well as the name of the audit companies the participants are from. During our interviews, we tried to remain as objective as possible in order to ensure reliability and validity in research. Also, it is important for the researchers to familiarise themselves with the characteristics of the organisation/group the participants are from (Saunders et al., 2009, p. 169). This way, we took in consideration the audit companies the participants are from and looked for information about it before conducting the interviews. Also it is important to make sure to not distort the answers of the respondents (Saunders et al., 2009, p. 363). During our data collection and analysis, we did not manipulate or falsify the data and respected the related ethical principles.
9
3.0 Theoretical framework
In this chapter we present the concepts related to our topic. We first introduce what is Earnings Management and continue with the concept of Goodwill. Finally, we will explain what an audit is and how it is related to the first two concepts. While introducing those concepts, we tried to give the reader an overview as global as possible.
3.1 Earnings management
3.1.1 Definition
Davidson et al. (2004, p. 267) define the concept of EM as “the use of flexible accounting
principles that allow managers to influence reported earnings, thereby causing reported income to be larger or smaller that it would otherwise be”. In other words, EM is about
managing the image and the impression the corporation reflects. In order to better understand that concept, Davidson et al. (2004) linked that phenomenon with the following theories: ethnostatistics, duality, impression management and agency theory. Those authors state that the main reason explaining the origin of EM is the fact that managers aim to reach personal goals which differ with the shareholders’ ones, thus raising conflicts of interests. Those conflicts are also explained by the information asymmetry: managers have more information than the shareholders when managing the business on an everyday basis, which allows them to act in favour of their own interest (Kouki, 2017, p. 188).
3.1.2 Motivations
Typically, a new CEO will feel the necessity to show the board they took the right decision to hire him/her and, in general, CEOs’ compensations are closely related and linked to the overall performance of the firm they manage (Davidson et al., 2004, p. 268). This is more specifically the stock market that is closely linked and related to determine managerial compensation (Nan Hu et al., 2015, p. 43). Indeed, a good and smart EM will be rewarded by markets and give huge financial compensations to the top managers (Call, 2019, p. 55). Those are the main reasons pushing the managers and CEOs to manage earnings. This way, EM can end up being either positive or negative, depending on managers’ targets and the economic situations they face or expect (Call, 2019). Furthermore, the motivation to manage earnings is within the scope of short-term goals and aim generally to fulfil an immediate need (Call, 2019, p. 55). Walker (2013) identified three other principal sources of motivation influencing EM. EM can be used for contracting motives, in order to achieve specific contractual targets that would not be reached without the manipulation of earnings. In particular, this motive applies when a firm is risking to breach a debt covenant involving the firm's’ earnings. EM can also influence the information of external investors for capital market motives. As a direct consequence, and, as an ultimate motive, the evolution of share prices will also be influenced, as well as the prices of initial public offerings and seasoned equity offerings. Finally, EM can be used in regard to third parties somehow related to the firm such as competitors, customers, suppliers, workers, regulators in order to influence the information those parties are able to access.
3.1.3 EM and CEO’s tenure
10 vesting period prohibitions and a sticky salary to do so. On the other hand, experienced managers, meaning with a long tenure and at top managerial positions, will be in a better position to fully benefit from EM due to the full responsibility of the firm’s performance they have. Call (2019, p. 62) states that the relation between the level of EM and a CEO tenure can be graphically represented by an inverted U shape. It means that the CEO use EM to maximise his benefits, until he assesses the situation as too risky after 5-6 years and decides to decrease the use of EM. Furthermore, other factors can influence the use and the level of EM, such as the government regulations, the marketing strategies, the CEO reputation and the CFO gender (Call, 2019).
3.1.4 Accrual and Real EM
To manage earnings and present financial results congruent with their own best and self-interests, managers push the flexibility of the accounting principles’ boundaries to its maximum (Kouki, 2017, p. 190) and find opportunities in complicated accruals and biased estimates (Call, 2019). There are basically two forms of EM (Call, 2019, p. 56). The first one is accrual-base EM (AEM) which uses the complexity and vagueness of accounting rules to either increase or decrease revenue and is partly characterised by estimates and manual journal entries. Therefore, one way to measure EM is the use of accruals (Legoria et al., 2013), and more particularly by focusing more on the specific accruals used to manage earnings than on the general accrual models, as for instance loan loss provisions, tax expense, goodwill impairments. Walker (2013, p. 453) defines the term accruals as the accounting adjustments that explain the difference between free cash flows and operating income. The particularity of AEM is it cannot affect total firm value if you have a given free cash flow (Walker, 2013, p. 453). The second form of EM is Real EM (REM), which is known only by the person(s) who initiated the EM and is responsible for it due to the fact that only that person knows the truth. REM “plays” with the scope and timing of business transactions to either boost earnings or increase expenses for no valid economic reason. For example, R&D is a common target of REM (Call, 2019, p. 59), as well as sales manipulation (Sundvik, 2019). Both AEM and REM can aim to shift earnings across accounting periods (Call, 2019, p. 59) and those two strategies form a trade-off guided by the financial health of the company when it comes to EM (Sundvik, 2019).
3.1.5 Accounting standards and EM
11 AEM is higher when the firm mainly follows principles-based accounting standards than when it mainly follows the rules-based ones.
3.1.6 Consequences of EM
EM may result in potential agency costs, by picturing a false and artificial image of the firm’s results and financial situation and influencing the decisions of investments that do not reach the best interests of the company (Davidson et al., 2004). This explains why investors and auditors need to have a critical judgment and to show scepticism when assessing stock prices or auditing the annual accounts, taking in consideration the ability of managers to manage earnings and their managerial tenure in the firm (Nan Hu et al., 2015; Call, 2019) As it is pretty difficult to find solid proofs of EM (Caruso et al., 2016, p. 143), most of the firms managing their earnings are still priced at a higher value than what they are really worth (Nan Hu et al., 2015). In addition to agency costs, EM also has several other internal costs. The time and the effort spent by the manager when managing earnings, which varies over the tenure, is definitely a cost to the company (Nan Hu et al., 2015). Besides, EM also jeopardises the company with legal liabilities (Call, 2019). Furthermore, EM also has negative impacts outside the scope of the company itself. A well-executed EM can also mislead the competitive environment of the latter, with rivals taking into consideration the performance of rivals to make forecasts and take decisions, and have negative impacts on the society (Call, 2019). Please refer to the Figure 1 below for an overview of the EM process, including its consequences.
3.1.7 Mitigating factors of EM
In order to prevent and decrease EM, Call’s study (2019) points out several mitigating factors. First, a strong corporate governance that does not pressure too ambitious short-term objectives and favour sustainable and realistic achievements will give reasonable goals to managers who will very likely meet the latter without using EM. The use of budgets can also help reducing EM, by monitoring the variations between the actual and the expected results, as well as a good follow-up from the Audit Committee and Internal Auditors.
12
3.2 Goodwill
3.2.1 Assets
Part of the Balance Sheet, which represents a statement of financial position, assets are economic resources expected to generate inflows in the future for the company that acquired it from past transactions (Griffin, 2013). Assets can be classified either as current ones, such as cash, accounts receivable, notes receivable, inventory, supplies, or as noncurrent (fixed) ones, such as land, building, equipment, furniture and intangible assets such as patents and goodwill (Griffin, 2013). Fixed assets are used to generate revenue, and this over their whole useful life, and that’s why their cost must be charged over the same period. Depreciation is “the permanent
and continuing diminution in the quality, quantity or value of an asset” (Pickles; Ramagopal,
2009, p.156) and allocates the cost of an asset over the period it is used. There is no depreciation regarding the current assets. Depreciation is therefore an expense that does not involve any cash outflow for the company, but which is crucial to take into account in order to not overstate the operational results (Ramagopal, 2009). The main depreciation’s methods are: straight line method, diminishing balance method and annuity method (Ramagopal, 2009).
Moreover, one shall also make the distinction between identifiable and unidentifiable intangible assets. According to Cohen (2005, p.49), “unidentifiable assets cannot be acquired
singly” and, therefore, identifiable assets, such as patents and copyrights, are identified mostly
based on their exchangeability criteria. Intangible assets are amortised when it is possible to assess their finite lives, and impaired when it is not possible to do so (Cohen, 2005)
Goodwill is the most common unidentifiable intangible asset, “composed” with several unidentifiable assets of the company, such as the culture of mentoring or the knowledge of the company (Cohen, 2005).
3.2.2 Definition of goodwill
Rashty (2018, p. 48) defines goodwill as “the excess amount that an acquirer is willing to pay over the fair value of the acquired reporting unit (acquiree) from the perspective of an appropriate market participant” in a context of business combination. In other words, goodwill is the excess of price over the fair value (FV) of net identifiable assets (fair value of assets minus fair value of liabilities) when a company acquires another business. The Figure 2 below represents graphically this definition. Once the business combination is done and the business transactions are over, the acquirer has to record the amount of goodwill as an intangible asset and test it for impairment at least once a year (Rashty, 2018). Even if goodwill is recognised as an asset, in other words, economic resource creating future economic benefits, both its measurement and relevance are still a source of debates (Van Hulzen et al., 2011, p. 94). When treating goodwill, specific regulations have to be followed and respected. The specific regulations and standards related to goodwill have been both a sensitive subject and a big challenge for decades and have been subject to several changes over time, trying different approaches, according to Betancourt and Irving (2019).
13
Figure 2 - Representation of goodwill
One can wonder why would anyone agree to pay more than the fair value of something. Cohen (2005) gives three reasons to that question: misidentification, mismeasurement and uncertainty. Indeed, people might disagree either on what counts as an identifiable intangible asset or on the method used to assess the FV of the asset; added to the fact that some unidentifiable intangible assets might have been developed internally (Cohen, 2005).
3.2.3 Recognition of goodwill
The recognition of goodwill can be either full or partial (Grathwohl and Voeller, 2016). In the case of a full goodwill method, one shall recognise the acquired goodwill, including the part of goodwill attributable to the non-controlling interests. In the partial goodwill method, the latter is excluded from the initial recognition. To better understand the difference between those two methods, Grathwohl and Voeller (2016, p.148) explain that “Non-controlling interests occur if
equity shares of a company are acquired, i. e. the business is purchased by way of a share deal rather than an asset deal (which results in full ownership of the acquired assets). For share deals, assets and liabilities are fully presented on the consolidated level. If the acquirer does not fully own the acquiree, non-controlling interests are recognized.” Under the US GAAP,
only the full recognition of goodwill is allowed. However, the IFRS rules, and more particularly the IFRS 3, offer a choice between those two methods. The differences resulting from the calculations of each method could have significant effects on both the valuation and the contracting perspectives of goodwill, and, therefore, have impacts on investors and creditors’ valuations and decisions. Significant effects are likely to happen only if the portion of goodwill attributable to non-controlling interests is itself significant. Basically, a company chooses one of the two methods according to its financial statements’ preferences and representation. Furthermore, Grathwohl and Voeller (2016) conducted a study and found out that the choice between those two methods affects the probability of future goodwill impairments.
14 3.2.4 Amortisation and impairment of goodwill
Before FAS 141 and 142, goodwill “would be capitalised on the balance sheet and amortised
on the income statement for some finite period” (Cohen, 2005, p.55). Indeed, companies had
to follow the rules of APB Opinion No. 17, issued in August 1970, based on the amortization of intangible assets. Opinion No. 17 was considering goodwill and the other intangible assets as wasting assets, which is the main reason for amortization. (FASB, 2001). In June 2001, this Opinion No. 17 got superseded by SFAS No. 142 providing a new guidance on the topic by introducing the FV recognition of acquired intangible assets, the amortization of intangible assets with a finite useful life and the impairment of goodwill. The reason for this new standard is the analyst’s constatation that intangible assets are an “increasingly important economic
resource for many entities” and, therefore, represent a big proportion of the total of acquired
assets in the context of transactions, raising a need for more detailed information about those assets (FASB, 2001). That new regulation implies required disclosures of information about goodwill and other intangible assets, such as the different changes in the carrying amount of goodwill, which is an additional tool for the users’ analysis (FASB, 2001). For a long time, many debates occurred regarding the decision to expense or capitalise intangible assets (Cohen, 2005). Both IFRS 3 and SFAS 142 aimed to improve the quality of financial reporting by replacing the amortisation by the impairment method (Van Hulzen et al., 2011). Indeed, amortisation “comprises a fixed expense charge every reporting period over the estimated
useful lifetime of the goodwill, with a maximum set at forty years by most accounting standard boards” (Van Hulzen et al, 2011, p.96) and it is not always possible to forecast the useful life
of goodwill and the pattern it diminishes. Under amortisation, the economic value of goodwill decreased in a straight line over time. The relevance of this model has been subject to a lot of debates and mixed results, especially regarding the relevant information it can be or not for the investors when evaluating share prices of companies and the tendency of arbitrary accounting it can lead to (Van Hulzen et al., 2011).
The Statement of Financial Accounting Standards (SFAS) 141 and 142 issued by the FASB, respectively about Business Combinations and Goodwill & Other Intangibles, have been the main standards to follow since 2005 when treating goodwill under the US GAAP scope (Betancourt and Irving, 2019). Those two standards aim to replace the practice of goodwill amortisation of historical costs (Knauer & Wöhrmann, 2016). According to Betancourt and Irving (2019, p.46), the second one, number 142, “replaced the requirement to amortise
goodwill with a periodic impairment testing approach” in two steps. In the first step, the global
FV of the reporting unit has to be compared to its carrying amount -book value- in order to determine which amount is lower/higher. If the former is lower than the latter, “the company
must then calculate any goodwill impairment charge by comparing the implied fair value of goodwill to its carrying amount” (Test 2). If that implied FV is lower, an impairment loss has
to be recognised, with an amount that is the difference. After receiving complaints from stakeholders regarding the excessive cost of impairment testing, the FASB first issued new rules in 2011 allowing companies to elect the assessment of impairment based on qualitative factors. In 2017, the board issued another new rule to simplify the test of goodwill impairment by eliminating the step 2 explained above and replacing it with a recognition of an impairment charge based on “the excess of a reporting unit’s carrying amount of goodwill over its fair
value”. The result of those changes gives the choice to private companies between amortisation
15 goodwill for impairment at least once a year, but its application differs in the way that it uses the concept of cash-generating unit, allowing the test for impairment at a lower level than it is under SFAS 142. Also, IAS 36 always followed a one-step approach from the start, similar to the SFAS 142’s one (Knauer & Wöhrmann, 2016). Under both IAS 36 and SFAS 142, firms must disclose indicators explaining the reasons of any material impairment loss recognition, either external or internal to the firms, and cannot proceed to any reverse goodwill impairment loss (Knauer & Wöhrmann, 2016, p. 424).
Also, it is important to notice that rules and standards about goodwill can differ depending on countries’ regulations. For example, LuxGAAP represents in Luxembourg the main standard to follow, and states that “Goodwill can be either treated as an intangible asset and then
amortised through profit and loss or directly deducted from the reserves” and that
“Amortisation is over five years unless management can justify a longer useful life.” (PwC, 2013b). Also, in addition to the annual amortisation, goodwill has to be reviewed for impairment every year and goodwill impairments can be reversed under LuxGAAP, with the recognition of a value adjustment in the profit and loss account (PwC, 2013b).
In Sweden, K3 has been the primary accounting standard to refer to since 2014 for all entities which fulfils more than one of the following requirements during the last 2 years; more than 50 employees, or balance sheet total of more than 40 million SEK, or more than 80 million SEK in net sales (BFN, 2017, p. 13). K3 is part of Bokföringsnämnden’s K-project and its structure mostly follows the structure of IFRS for SMEs, with some deviations. Smaller entities have to follow standard K2 based on the Bokföringsnämnden’s standard (KPMG, 2016). In K3’s scope, goodwill is recognised using the full-goodwill method is usually amortised over 5 years, however, an entity may state a longer useful life if it can provide material that supports this (PwC, 2013a, pp.796-797). Goodwill is not subject to annual impairment test in K3. Amortisation nor write-downs of goodwill is not permitted to be re-instated (BFN, 2017, p. 150).
3.2.5 Debates around the goodwill standards
16 impairments and an overvaluation of companies by the investors due to inflated goodwill balances.
3.2.6 A possible come back to amortisation?
As the current standards regarding Goodwill are still highly questioned, the FASB issued in 2019 an invitation to comment (ITC) in order to receive some feedback and opinions about the application and consequences of the current rules regarding the impairment method and assess what needs to be done (Betancourt and Irving, 2019). FASB (2019) stated that “Assuming that
a cost-benefit issue exists with the subsequent accounting for goodwill, one approach to addressing the issue would be to reintroduce goodwill amortisation for PBEs [public business entities].” They also state that a reintroduction of amortisation would have several material
impacts on the companies’ key financial ratios, and more particularly on return on assets (ROA) and earnings per share (EPS).
3.3 Audit
3.3.1 Definition and purpose
Griffin (2017, p.1) defines the concept of audit as “an objective examination of the financial
records, internal controls and financial reports (i.e., financial statements) of an organisation to assure that the financial reporting is done in a fair and accurate way”. An audit can be either
external or internal. An external audit is an independent assessment of the financial statements and internal controls of a company made by external auditors, usually Certified Public Accountants. In that first case, the goal is to express a fair and objective opinion about the accuracy of the company’s financial statements to outside parties (creditors, investors, and so on). In the case of an internal audit, auditors are part of the organisation and help to improve everyday operations and controls, determine risks and give advice and recommendations in order to increase the performance of the firm (Griffin., 2017). Regarding our study, we will focus only on the external audits.
The ultimate goal of external auditors is to obtain first sufficient evidence and then a reasonable assurance, meaning, a high assurance that is not 100% free from error, that the financial statements do not contain material misstatement and are presented fairly according to a specific financial framework. A misstatement is a difference between the amount of an item/account reported in the financial statements and the amount it should be under the related applicable financial reporting framework. This misstatement is called material when it is likely to have any influence in the decisions and conclusions the users make, meaning that the users would see things differently without this misstatement and make different choices. In order to assess the risk of material misstatements, auditors consider five assertions: existence or occurrence, completeness, valuation or allocation, rights and obligations, presentation and disclosure (Griffin, 2017).
3.3.2 Audit process
Mactavish (2018, p.388) points out four main stages of the audit process, all related to specific auditing tasks. The first one is about “ethical requirements, professional skepticism, quality
control and association judgments”, which sets the background of the audit and will have an
17 planification one and covers basically the following tasks: risk assessments, analytical procedures, and materiality. This stage is essential as it aims to detect errors and fraud, including earnings management, in financial statements and also impacts the subsequent audit tasks. To get further information about those tasks, please refer to the study of Mactavish (2018). The planification stage is followed by the execution and evaluation of judgements in the third stage, which is very likely to request the use of specialists and experts in order to assess the findings of the audit, such as misstatements and evidence sufficiency. Here also, as in the goodwill part of this theoretical framework, one issue is to properly and effectively assess management’s fair value measurements with an acceptable reliability. Finally, the fourth and last phase concerns the reporting tasks and the evaluation of the entity's ability to continue as a going concern, using both past and future evidence. Please refer to the Figure 3 below for an overview of the audit process.
Figure 3 - Simplified overview of the audit process
3.3.3 Audit and quality
Chersan (2019) highlights the growing importance of the quality of the services provided by the financial auditors, especially after several big financial scandals and crisis occurred in the 2000’s where auditors, not always neutral, played an important role. The author (p. 96) defines audit quality as “the dual probability of the auditor’s discovery of significant misstatements
and their reporting”. The audit quality is relevant in the way it increases the confidence in the
financial market. According to Chersan’s study (2019), it is not possible to analysis each of the numerous determinants influencing the audit quality and that can be hard to detect. However, the author (p. 96) states that the first components of audit quality are “the acquirement,
18
the legislation and professional regulations applicable to the financial auditors”. Standard
setters have been aiming to develop a reliable portfolio of audit quality indicators (AQIs) (Brown & Popova, 2019). In 2015, the Public Company Accounting Oversight Board (PCAOB) issued a new release about 28 possible AQIs related to the audit professionals on an engagement, the audit process and the audit results. The audit quality has consequences on users’ decision making. Indeed, Brown and Popova (2019) conducted a study and concluded that investors receiving bad audit quality indicators will more likely choose to decrease their investment in the company. However, audit quality is hard to properly assess, as well as its impacts (Gao & Zhang, 2019).
3.3.4 Auditing standards
In addition to the expertise and the incentives of auditors, audit quality is also affected by the auditing standards, which are “useful in mitigating the auditors’ possible misalignment of
interest with investors” and have economic consequences, according to Gao & Zhang (2019,
p.1). Even if those standards provide a certain guidance to auditors and push them to do more work, it also reduces their scope of professional judgment, leads them to some kind of compliance mentality and reduces their acquisition of expertise, which makes auditing standards a highly controversial subject (Gao & Zhang, 2019). Several auditing standards exist nowadays and auditors have to follow the ones that are related to their country in general. The IAASB issues the International Standards on Auditing (ISA) and International Standards on Quality Control (ISQC) (Zietsman, 2019). According to Zietsman (2019), ISAs are used by more or less 120 countries in the world, using different bases and committing at different levels. The author (p. 22), who is also deputy chair of the IAASB, confirms that ISAs form “the
foundation for the performance of quality audits”. Boolaky & Soobaroyen (2017) highlights
that ISAs are one of the key standards for financial systems alongside IFRS and that offering audit services in line with international standards is very likely to result in reputational and financial benefits. The authors’ study shows that the adoption and harmonisation of ISAs are highly dependent on the institutional factors, such as regulatory enforcement, lenders and borrowers rights, foreign aid and so on, and even more than on the economic ones. Auditing standards typically involve accounting firms, standard setters and international/national financial market regulators (Boolaky & Soobaroyen, 2016).
19
4.0 Literature review
In this section, we explore articles that relate the three main concepts of our study, that is to say, EM, Goodwill and Audit. We aim to present the main issues related to those concepts and to have a better understanding of the importance of goodwill in EM, the impacts of the goodwill amortisation abolishment and the introduction of goodwill impairment, and also of the auditor’s view and the audit quality in relation to EM in goodwill.
4.1 Role of goodwill in EM
A problem in providing evidence of using goodwill as a tool for EM, is that it is nearly impossible to provide indisputable evidence of EM practises (Caruso et al., 2016, p.143). A study by Pajunen & Saastamoinen (2013) investigated auditors’ perceptions whether IFRS enables EM in goodwill or not, and found the auditors to agree that the current rules provide opportunities for EM, although the opinions were mixed on the existence of EM in goodwill. However, recent studies have found several factors and implications that the introduction of impairment testing on goodwill has led to an increased presence of EM. After the adoption of IFRS, Hamberg et al. (2011) discovered a strong relation between abnormal earnings due to the abolishment of goodwill amortisation. Caruso et al. (2016) found a significant change in managers’ behaviour on how they account for goodwill. The decision to impair goodwill was often subject to high or low write-offs, which was not present before when using amortisation of goodwill. Furthermore, a similar paper that further explains this behavioural tendency is Knauer & Wöhrmann (2016). Their study shows the negative market reaction which is associated with unexpected goodwill write-downs, leading investors to lower expectation in a negative way. If the explanation of deciding to impair goodwill is internal, the market reaction will be even more negative due to the unverifiable nature of internal information (Knauer & Wöhrmann, 2016, p. 446). Knauer & Wöhrmann (2016) also propose that legal protection can restrict managerial discretion and improve the accounting information.
4.2 Opportunistic behaviour and role of compensation
20 whose compensation is largely based on cash-bonuses, the amount of recognised goodwill in a business acquisition will increase (Detzen & Zülch, 2012, p. 124). Indeed, during the initial recognition of goodwill, the structure of the CEO’s compensation package will have an impact on the purchase price allocation to goodwill (Grathwohl & Voeller, 2016). Studies by Korošec et al (2016), Ramonna & Watts (2012) and Beatty & Weber (2006) show that companies' remuneration system affects the decision whether to recognise goodwill impairment or not, further emphasising the importance of managerial behaviour within this topic.
4.3 Time factor and accounting quality
Li & Sloan (2017) showed that the transition towards impairment of goodwill has led to an increase in untimely goodwill impairments, which could be related to managers’ tendency to avoid impairments to a great extent. However, Van Hulzen et al. (2011, p. 114) and AbuGhazaleh et al. (2011, p. 197) argue that timeliness within impairments of goodwill has increased and thus increased the accounting quality compared to before when amortisation was used. Van Hulzen et al. study (2011, p. 114) found that the gap between the real decline in economic value of goodwill and the recognition of goodwill in the financial statements, had decreased. Furthermore, AbuGhazaleh et al (2011, p. 197) found that after the adoption of IFRS 3 in the UK, it improved the quality of reported goodwill impairment losses and enabled firms to better reflect their underlying economic value. The opposite views on goodwill’s effect on accounting quality shows a need for further research.
4.4 Discretion and Verifiability problem in goodwill impairment testing and FV
21
4.5 Audit quality and Goodwill
Pajunen and Saastamoinen (2013) found auditors to be split between preferring goodwill treatment in regards with IFRS or using amortisation. Since the replacement of goodwill amortisation with goodwill impairment, new challenges for auditors have arisen that ultimately impacts audit quality (Ayres et al., 2019, p. 103). Auditors have been facing those challenges by developing new tools to assure audit quality. According to Call (2019), auditors developed strong analytical tools in order to detect the practice of AEM. Ayres et al (2019, p. 103) found that the main new challenges for auditors related to goodwill impairment include; technical challenges (inspection deficiencies), managers’ misalignment in incentives for whether to decide to impair goodwill or not (a manager is likely to avoid goodwill impairments), and the likelihood of auditor dismissal due to goodwill impairment. It is found that a positive relationship exists between recording a goodwill impairment and dismissal of the auditor (Ayres et al., 2019). The risk of auditor dismissal can be connected to being a relationship challenge. A study by Lobo et al (2017) investigated the use of big 4 auditors and its implications on goodwill impairment in France. They found that the use of two big 4 auditors decreased the chance of goodwill impairment, which may indicate bias resulting from the relationship between the firm and auditor (Lobo et al., 2017). This can be further reinforced that big 4 auditors tend to not believe in opportunistic behaviour from management, while auditors with a more recent degree view EM risk in management (Pajunen & Saastamoinen, 2013). However, Big 4 audits are believed to be of higher quality due to them being less dependent on individual clients (Albersmann & Quick, 2020, p. 96). The ability to avoid bias can be key in regards to audit quality, auditors have a vital part in the process of producing the “true” value of goodwill together with management and the firm itself (Pajunen & Saastamoinen, 2013, p. 247). Time pressure on the audit is negatively associated with earnings quality which in turn has negative effect on audit quality (Lambert et al., 2017, p. 65). An important aspect regarding audit quality is timeliness of goodwill impairment and the impact of managerial discretion (Albersmann & Quick, 2020). A study by Albersmann & Quick (2020) found several factors which increased the timeliness of goodwill impairment which include; the firm using big 4 auditors, higher audit fees and shorter audit tenure. Conversely, factors which decrease audit quality and timeliness of goodwill impairment were found to be longer audit tenure and high non-audit fees (Albersmann & Quick, 2020). Thus the role of independence of auditors is another important factor that emphasises the ability to take an unbiased overview will in turn affect the audit quality (Albersmann & Quick, 2020).
4.6 EM in private vs. public firms
23
5.0 Research method
In this chapter, we will describe how we collected data and why we chose to conduct semi-structured interviews. We will explain how we constructed the questions of our interview guide, based on our literature review, and present those questions. After giving more details about the interviewees, we will present how we analysed the interviews.
5.1 Data collection
Two types of data can be collected: primary and secondary data. Saunders et al. (2009) define primary data as data being collected specifically within the scope of the research project being conducted. It is quite common to collect primary data either through observation or using qualitative interviews and questionnaires, according to Saunders et al. (2009). On the other hand, the authors define secondary data as data that has been collected in the past for a specific purpose, and that is reused again in the context of a new research project. Secondary data can be either raw data or compiled data, publicly available or private, such as data collected in daily business operations of companies or using a survey, and can be used for both descriptive and explanatory research (Saunders et al., 2009, pp. 256-258). Even if secondary data might show advantages in comparison to the primary data, such as fewer resource requirements (time and money) and quicker to obtain, it is likely that those pre-collected data does not match the need of the current research it is reused for, added to the fact that accessing those data might be difficult and/or costly and that the research reusing the data cannot have any control over its quality (Saunders et al., 2009, pp. 268-272).
Regarding the choice of data collection within the scope of our study, we took into consideration the advantages and disadvantages of the two methods, the availability and status of current data, but we mostly considered our specific topic and the research question’s data requirements. Indeed, we aim to present and compare the views of both Luxembourgish and Swedish auditors concerning the topic of EM in goodwill, in both private and publicly listed firms. To the best of our knowledge, we did not find any study that collected that kind of specific data. The most related academic article we found is a quantitative study assessing the Finnish auditors point of views regarding EM in goodwill in 2013 by Pajunen and Saastamoinen, which differs from our study in terms of method analysis, populations and IFRS updates regarding goodwill. Thereby, we chose to gather primary data.
5.2 Qualitative data collection and semi-structured interviews
5.2.1 Semi-structured interviews
24 different standards, respectively Lux GAAP and K3, which is another reason why we believe semi-structured interviews are highly appropriate in this study. Please refer to the theoretical part of this study for more information about Lux GAAP and K3. In order to get as many diverse opinions as possible and get interesting insights, we interviewed auditors of different status: junior, senior and manager; meaning they are more or less experienced in audit and, this way, we expect them to perceive things quite differently. Semi-structured interviews seem well appropriate to reveal the possible differences auditors express during the conversation about EM in goodwill.
5.2.2 Qualitative sampling technique
As it is quite hard to collect data from each individual person or case of a specific population, sampling techniques provide methods that aim to reduce the amount of data by focusing only on a sub-group of this specific population (Saunders et al., 2009). For example, in our study, our population is composed of every auditor part of Luxembourg, but it is not feasible for us to interview such a big population. Furthermore, given the time constraints we have to conduct our master study, it is inevitable for us to choose a sample method. There are basically two types of sampling techniques (Saunders et al., 2009, p. 210): probability (or representative) sampling and non-probability (or judgemental) sampling. In the first one, each case (or person) of the overall population has the same probability to be selected to constitute the sample. This type of sampling suits well the need for statistical inferences and includes the following techniques: simple random, systematic, stratified random, cluster. On the other hand, the non-probability sampling techniques don’t allow to know the non-probability of each case (or person) to be selected from the overall population and the sample size can be an issue to decide, as there are no rules. This type of sampling includes techniques such as: quota, purposive, snowball, self-selection, convenience. Both types of techniques can be used when conducting a study (Saunders et al., 2009).
