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How to reduce errors in applying impairment tests - an empirical analysis

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Fair value accounting has become predominant in accounting as a vast number of IAS/IFRS standards are based on fair value accounting, including IAS 36 Impairment of assets. Fair value accounting for goodwill is technically challenging, since market prices are not observable. Thus, valuation technologies must be applied in order to test goodwill for impairment.While prior research on goodwill has concentrated on either the (dis)advantages for each accounting procedure for goodwill or examined the value relevance of goodwill (amortization) and goodwill write-offs, little effort has been devoted to the technical problems in the implementation of IAS 36. However, recent research on the topic document that firms commit a variety of errors in applying IAS 36 (Petersen and Plenborg, 2007).We examine firm characteristics that might explain the frequency of errors that firms commit in applying impairment tests. Our findings suggest that at least two factors might explain why errors are present – the lack of an impairment manual and not involving employees with rigorous experience in firm valuation.Our research, which might be seen as the fist step toward guidelines in applying technically challenging accounting standards, should be of interest to firms, auditors and standard setters.

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Christian Petersen, Thomas Plenborg

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