Purchase Price Allocation upon Business Combination and Its Effects on Balance Sheet’s Value Relevance

• In Event: Financial Accounting and Reporting 4

Abstract

This study examines the effect of purchase price allocation upon business combination and evaluates its impacts on accounting information’s value relevance by contrasting the value relevance between the balance sheet items and the income statement items. Value relevance is measured by the R2 from regressions of stock prices on book values and earnings measures. Using SDC Mergers and Acquisition Database, this study identifies acquiring firm-years when the reporting entity has the discretion of purchase price allocation and non-acquiring firm-years when no such discretion is exercised in financial reporting. Accounting information’s value relevance between the two groups is studied and the contrasted between the balance sheet and the income statement. Book value equity is then decomposed into identifiable intangible assets, accounting goodwill and other book values for further analysis.
Empirical results show that acquiring firm-years have higher intangible assets and goodwill, and lower value relevance for book values. When decomposed into asset components, empirical evidences show that effects of purchase price allocation affect asset components’ explanatory power. The effects are not limited to intangible-intensive industries.
Through purchase price allocation, business combination provides opportunities for the acquiring firm to exercise discretion on the structure of its balance sheet. Findings in this study indicate that the market does not positively value the additional intangible assets capitalized upon business combinations.

Author

• Kang Cheng, Morgan State University