How Is Goodwill Impairment Driven by Relative Firm Performance - Research Proposal Example

How is goodwill impairment driven by relative firm performance? Evidence from Germany Table of Contents Introduction 3 Problem ment 4 Aims and objectives 5 Research Questions/ Hypothesis 6 Background and Rationale/Justification 8 Overview Literature Review 9 Research Methodology 10 Methods of Analysis 13 Resources 14 Timescale/plan 14 Reference List 16 Introduction Recognition of goodwill and its measurement was questioned for several years due to which International Accounting Standards Boards (IASB) had introduced new standards that altered the treatment of goodwill during 2004. Hence, it can be stated that goodwill had encountered several change in terms of regulations over the few years. These regulations are related to amortization of goodwill. Under the regulation, the goodwill will not be amortized rather it will be tested at annual basis for impairment. According to International Financial Reporting Standard, goodwill is defined as the asset, which provides future economic benefits arising from the assets; these assets are not identified and recognized. Hence, they are obtained as excess cost of the acquired entities over the fair value of liabilities and assets (Ding, Richard and Stolowy, 2008). The concept “goodwill” was first introduced by Financial Accounting Standards Board (FASB) during June 2001 with the help of statement of Financial Accounting Standards (141 and 142) under the rules and regulations of Generally Accepted Accounting Principles (GAAP) of the United States (i.e. US GAAP) (Wiese, 2005). However, there was modification in the issuance of the concept during 2004. It was revised for international convergence, which actually took place after four years. Churky (2005) had studied the relevance and appropriateness of new standards related to goodwill impairment with the help of test market valuation, which discovered that there is evidence for weak impermanent of the goodwill. Further, research was done by Devalle and Rizzato (2012) focussing on the quality of mandatory disclosure that is related to the goodwill impairment. Their research identified that there was low disclosure index and huge difference between stock market performances. Vichitsarawong (2007) had also studied the relevance of goodwill impairment by examining relative efficiency of the companies in the US. His study revealed that goodwill impairment identifies decrease in comparative efficiency of the companies. The study aims at deciphering the relationship that is developed by Vichitsarawong (2007) with respect to goodwill impairment; however, in this research, emphasis has been given on European realities Germany. The main reason for selecting Germany for the research lies in the fact that it is the largest economy in the European nation. It also presents the highest Gross Domestic Product (GDP) of the nation over the past years. The commercial and accounting policies of Germany was affected by the regulations of European Union with the increase in integration in the country. It is observed that the German culture has the ability to influence the quality of accounting policies and reporting; thus, it is easy for interpreting the goodwill impairment in context of IFRS (Chambers, 2006). Problem statement Measurement of goodwill has encountered severe challenges due to changes in regulations. According to IAS 36 (2004), the goodwill will be subject to impairment test on the annual basis. This change in the regulation of goodwill measurement has the ability to alter the performance of a firm. Thus, the research gives emphasis on the changes that are evident in the performance of firms due to the new regulations related to impairment of goodwill. Therefore, the main aim of the study is to compare the difference between non-impairment and impairment firms and years. This study is essential in order to support further researches pertaining to goodwill impairment. In the study, the research of Vichitsarawong (2007) was applied in the European context, where the German companies are tested for the impermanent of goodwill and its effect on the overall performance. The research also gives managerial implications that are related to the financial performance of the companies. It will also help the investors and auditors for understanding the relevance of current accounting standards related to impairment and recognition of goodwill. Aims and objectives The main aim of the research is to depict the affect of new regulations related to goodwill impairment on the performance of companies. In this regard, the performances of German companies are evaluated and the impairment teats are carried out. The main goal of the researcher is to examine whether there is any effect of goodwill impairment on the financial and overall performance of the German companies. In order to achieve the research aim, few objectives are developed, which helps in achieving the main goal of the study. The objectives lay emphasis on the following steps that are important for developing the main structure of the research. 1) To examine the treatment of goodwill over the passage of time. 2) Evaluate the relevance of value of goodwill impairment, which marks the change from amortization of goodwill to impairment of the assets. 3) To examine how impairment of goodwill affects the overall performance of German firms. The research objectives are necessary for developing the structure of the research so that the research aim is accomplished. Research Questions/ Hypothesis The research developed by Vichitsarawong (2007) aimed at establishing the relationship between the efficiency of companies and goodwill impairment. The relevance of the research was to decipher the usefulness of goodwill impairment under the new regulations. Similarly, this particular research intends to examine the association between goodwill impairment and overall performance of German firms. The research carried out by Vichitsarawong (2007) laid emphasis on the US market, which follows the US GAAP, but this particular study concentrated on the European reality that follows the IFRS. The principles in both the cases are similar; however, there is little difference in approaches of US GAAP and IFRS. It can be stated that US GAAP can be used for avoiding the impairment loss than following IFRS principles. Hence, the outcome of this research may differ from the results of GAAP that was followed by the American companies. Germany is selected for the research as it is the largest economy in Europe. Though IFRS is not significant in Germany, the study gives emphasis on the European reality as the countries holds a stable environment. According to Bertomeu and Magee, (2011) during the period of adversity, accounting regulation is considered important as it may alter the performance of a company to a great extent. Researchers like Kousenidis, Ladas and Negakis (2013) had studied that the earning quality of companies had improved during the crisis period, however; there is significant deterioration in the reporting quality when there are incentives for the earnings management. Hence, it can be stated that incorporation of the crisis years in the analysis will have significant change in the results. In this context, the following research questions are developed: 1) What is relationship between goodwill impairment and performance of firms? 2) How the new regulations related to goodwill impairment affected the financial and overall performance of the German companies? Five hypotheses are developed for the accomplishment of the research aims are described as below: H1: Impairment represents that there is low performance compared to that of non-impairment companies in same year of goodwill impairment and recognition. H2: If the impaired companies reports that there is impairment in the consecutive years, then its performance is expected to be become high in first year (i.e. impairment reporting) as compared to the following year (i.e. impairment reporting). H3: In two consecutive years, if firms report goodwill impairment in the first year but not in the second year, firms performance is lower in the first year (of impairment reporting) comparing to the second year (of no impairment reporting). H4: In two consecutive years, if firms report goodwill impairment in the second year without having reported in the first year, performance of the firm is higher in the first year (of no impairment reporting) comparing to the first year (of impairment reporting). H5: If impairment firms do not report goodwill impairment in two consecutive years, firm performance is lower in the first year (of no impairment reporting) comparing to the second year (of no impairment reporting). Background and Rationale/Justification The rationale behind carrying out this study is to examine the relationship between goodwill impairment in the financial statement of companies and its overall performance. Though there is very few researches pertaining to the topic, but the research carried out by Vichitsarawong (2007) had laid a foundation stone for this particular study and encouraged to evaluate the performance of the German firms. The author had justified that there is significant relationship between goodwill impairment and its performance through the study carried out in the US market, which follows the US GAAP. However, this study focus on the companies in the European market, which abides by IFRS codes for preparing its financial statements. In this research, the impairment test is done in two steps, which are discussed henceforth: 1) The first step gives emphasis on identifying the potential impairment. In this step, a comparison is done between the fair value of the reporting units and its carrying amount. When the fair value of the reporting unit is higher than that of the carrying amount, then there is no recognized impairment. Similarly, if the reverse situation takes place, then there is impairment recognition. If there is recognition of goodwill impairment, then the second step should be considered. 2) The second step is concentrated on recognition of goodwill value impairment. The carrying amount of goodwill and fair value of impairment is compared in this case. When the carrying amount of the goodwill is higher than the fair value of the goodwill, then the excess amount is recognized for impairment loss. The impairment tests are generally executed annually; however, it can be repeated many a times in a year if certain circumstances takes place such as advert changes in external environment, legal changes, action undertaken by the regulators and unpredictable competition. Hence, goodwill impairment is readily needed for valuation of the goodwill. Overview Literature Review Accounting regulations are significant for explaining the background of goodwill treatment. There are several literatures pertaining to relevance of goodwill impairments prior to the changes that has taken place according to new accounting standards. IFRS has defined goodwill as the asset that represents future economic that are not potential enough to be recognized individually. Hence, it is recognized as the excess cost for the acquired entity maintained over the fair value of the liabilities and assets (Ashbaugh, LaFond and Mayhew, 2003; Churyk, 2005; Lee, D.S., Mikkelson and Partch, 1992). The goodwill value is developed based on the combining entities, which is related to the improvements in efficiency of the management. Goodwill is also generated from integration of several processes and improvement of production techniques that are added directly to the financial statement of the company (Banker, Charnes and Cooper, 1984; Kimbrough, 2007; Lakonishok and Lee, 2001). As for example, during the period 1990 to 1994, the volume of goodwill represented a significant portion of the firm i.e. about 20% of the asset of the business. Goodwill has encountered severe changes over the past few years due to change in policies and regulations. According to Ding, Richard and Stolowy (2008) there is four main phases that is associated with evolution of treatment of goodwill between the periods 1985 to 2005. It also focuses on the four capitalist countries of the West such as Great Britain, France and the United States (Elliott and Shaw, 1988). The first phase considers the static phase i.e. the non-recognition phase. It indicates that goodwill is referred as the true asset, which should be expensed instantaneously within a definite period of time. The second phase refers to weakened static phase, where goodwill is represented as equity after combining the two distinct arguments (Barth, et al., 1999; Banker, Charnes and Cooper, 1984; Olante, 2013; Osborne, Dominion and Groningen, 2012; Park and Jang, 2013). The first arguments relates to the fact that goodwill is not an asset and the second argument indicates that goodwill should offer opportunity for dividend distribution from present profit. The third phase describes the dynamic phase, which claims that the acquired goodwill is systematically amortized for reducing the current income. The fourth phase is the actuarial phase and it does not go with goodwill amortization and thus suggests for impairment tests so as to examine the difference between fair value and carrying amount of goodwill (Barth, et al., 1999; Banker, Charnes and Cooper, 1984; Lau, 2011; Leuz and Wustemann, 2003; Leuz, Nanda and Wysocki, 2003; Masters-Stout, Costigan and Lovata, 2008). Research Methodology The research methodology is very significant for the completion of any research. It lays a foundation for the research describing the process that will be followed and forming the structure in which the topic will be arranged. The structure helps in deciphering the research aim, which is important for making the research successful. The methodology takes into account research approach, research philosophy, research strategy, research methods, data collection, research design, sampling, limitations of the study and lastly ethical considerations. Research Philosophy It explains the fundamental structure of the research with the help of which relevant data are collected for conducting the research work. The philosophy ensures that the data collected in the research process are well utilised and analysed to fulfil the actual motive of this study. The conventional theories employ different research philosophies, within which interpretive philosophical approach is employed in this case. The research gives emphasis on interpreting the ideas and opinions of different authors regarding the topic and interprets the outcome after considering the mentioned facts (Saunders, Lewis and Thornhil, 2012; Saunders, Lewis and Thornhill, 2009). Hence, it is easy for the researcher to interpret the ideas and opinion of the authors and collect data pertaining to the topic. Research Design The research design actually describes the blue print of the steps that are carried out for fulfilling the main research aim. The review of previous literatures that are prepared by different author helps in laying a strong foundation stone for this particular research. In this case, both longitudinal and cross-sectional analysis is executed in order to achieve the research aim. The study considers three industries i.e. durable, technology and service industry. The effect of goodwill impairment is tested in this industries both longitudinally and cross-sectional. The cross sectional analysis requires some changes pertaining to size of the company so as to eradicate the presence of outliers, which may result in bias outcomes. The data for cross sectional samples includes the average total assets of the companies, who own about one billion euros to 20000 billion euros. Research Method The research method aims at explaining the primary steps that are considered for accomplishing the objective of the research. In this project, both quantitative and qualitative research is applied. The qualitative research is important for the development of literature review, which depicts the ideas and opinions of different authors. The review not only lays emphasis on the ideas that are generated by different authors, but it also justifies the opinion that is stated by Vichitsarawong (2007) with regard to the US companies. However, in this research, the details of the German firms are considered for analysing its goodwill impairment. Therefore, quantitative research is also carried out in this regard so as to justify the opinion provided by Vichitsarawong (2007) in the context of German companies. The quantitative research is related with the definition of epistemological methodologies in order to identify true-value of the propositions and hence allow adaptation of the data so as to do a comparative analysis and more. The statistical tools are employed for analysing the data, which are collected from different source of information. The main advantage of applying quantitative research is that comparative analysis and replication is possible with the data (Lawrence, 2006; McBurney and White, 2009; Saunders, 2009; Bhattacharyya, 2009). The researcher can independently measure the effectiveness of the data and whether they are reliable and valid for the successful completion of the research. In this research, the quantitative data of the German companies are required so as to calculate certain ratios, which will help in developing an idea regarding goodwill impairment. Research Approach There are three main research approaches which are used in the corporate as well as academic researches. They are inductive, deductive and adductive. The inductive and deductive approach is the two main approaches, which are generally used for preparing social science research projects. The approaches follow different paradigm. For this research, the researcher has selected deductive approach in order to achieve the main research aim. By applying this method, the researcher has first established research questions in order to examine the reliability and validity of the statements (Leedy and Ormrod, 2005; McDaniel and Gates, 1998). The researcher has developed the research questions based on the information that are provided in different source of information. The research question aims at establishing the relationship between impairment of goodwill and performance of the firms. Limitation of the Study The main limitation of the study is that the research has considered limited number of companies’ data for the cross-sectional and longitudinal analysis. Therefore, possibility of inaccuracy of the results increase as the sample size is low. There are very limited studies pertaining to the topic hence, it is difficult to obtain information from the existing researches and check for validity. In this case, the results of the cross-sectional and longitudinal analysis cannot be compared with other author’s researches so as to examine its reliability. Ethical Considerations During the preparation of the research work, it is significant to abide by few ethical standards, which are essential for avoiding any research related issue. In this case, the researcher will collect the data from the German companies authentically and do not have any motive to manipulate them so as to deliver distorted results. Hence, the company data are used if they are obtained from authentic sources. Methods of Analysis In this research, the following data are analysed with the help of following analytical tools: 1) Statistical analysis: t-test and Wilcoxon rank sum total 2) Financial analysis: Ratios are calculated such as operating cash flow to sales, earnings before taxes excluding unusual items to sales and equally weighted average of the two mentioned variables. Resources For accomplishing the main aim of the research, both primary and secondary source of data are employed. Both the data are collected very carefully so as to obtain accurate and valid results pertaining to the topic. Timescale/plan The mentioned timetable is followed for accomplishing the project in time. Month Particulars 1 2 3 4 5 6 7 8 Identification of research topic after going through a number them Consulting the supervisor for selecting the best one Final selection of the topic Preparation of research proposal Receiving feedback from the supervisor and start on the research Preparation of the introduction part after collecting suitable data Framing the research questions and hypothesis Start and finish the literature review Preparing the methodology Collect data for the analysis part Findings and analysis Conclusion and recommendations Reference List Ashbaugh, H., LaFond, R.and Mayhew, B.W., 2003. Do nonaudit services compromise auditor independence? Further evidence. The Accounting Review, 78(3), pp. 611-639. Banker, R., Charnes, A. and Cooper, W., 1984. Some models for estimating technical and scale inefficiencies in data envelopment analysis. Management Science, 30 (9), pp. 1078-1092. Barth, M., Beaver, W., Hand, J. and Landsman, W., 1999. 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Accounting for goodwill: The transition from amortization to impairment- an impact assessment. Stellenbosch: University of Stellenbosch. Read More