Information Content of Negative Goodwill

• In Event: Emerging Research Session III: Issues in Financial Accounting

Abstract

This study is among the first to look at SFAS 141R and evaluate the accounting treatment of bargain purchase gain and its implications on market participants. SFAS 141R is the first global standard issued jointly by FASB and IASB since the two regulatory bodies began their joint rulemaking convergence project. I look at two specific questions: First, I evaluate whether companies strategically allocate a larger portion of purchase price to negative goodwill. The accounting treatment of bargain purchases implies that the more a company allocates to negative goodwill the more will be recorded as bargain purchase gain, and therefore the higher the acquirer’s EPS. Negative goodwill is created when a company buys an asset –including another company – for less than the asset's current fair value. Prior to SFAS141R companies would write down the gain by reducing the recorded value of the assets acquired and immediately recognizing any remaining amount as an extraordinary gain. Under SFAS141R the entire negative goodwill created is immediately recorded in earnings as an ordinary gain. The second question I look at is whether – and in what direction – the market reacts to the accounting treatment of bargain purchase gain. The implication of bargain purchase gain for future earnings is relatively straightforward. Although embedded in ordinary earnings, this is a nonrecurring non-cash gain. I examine the information content of bargain purchase gain by looking at the short-term (three-day window) industry adjusted market reaction to the disclosure of this gain.

Author

• Shira Cohen, Columbia University