M&a Accounting and Their Effects to Stock Prices

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Merger and Acquisition accounting in the UK
and their effects to stock prices

by
Yan Shao
2006

A Dissertation presented in part consideration for the degree of MA in Finance and Investment

Abstract
There has been considerable controversy surrounding the accounting practices for mergers and acquisitions. The focus of this controversy has been on the differences in financial statements that arise under the two accounting methods: merger (pooling-ofinterests) (Add together the book values of the assets and liabilities of the two companies) and acquisition (purchase) accounting (Add the fair values of the target’s assets and liabilities at the date of acquisition to the book values of purchase’s assets and liabilities). They are simply in no way to alter the underlying nature of the business combination. However, the two methods do result in substantial differences in the way the financial statements appear subsequent to the combination. The main objective of the dissertation is to investigate whether they have a different effect on the stock prices of acquiring firms during the combination period, and whether their abnormal returns (firms with different accounting treatments) during the combination period are different or not.

The methodology that has been used in this analysis is event study, the sample firms (listed in London stock exchange) are chosen from the M&A cases in the UK dated from 2000 to 2006. They have been divided into two groups – purchase and pooling group. Their effects to the stock prices are examined by the Market model developed by Fama (1969) that assumed a linear relationship between the return of any security to return of the market portfolio, and the independent T-test that uses to assess the statistical significance of means between the two groups and two sub-groups.

The research result is partly consistent with earlier studies of the different accounting method effect, which indicates that whether pooling-of-interests or purchase accounting is applied in a business combination is irrelevant. However, in a wider examined period, the result acts reversely. In the test of the sub-groups, one earlier group gives similar results, while the other group demonstrates no significant difference between the stock prices of the purchase and pooling firms within all the three examined periods.

I

Table of contents
Abstract …………………………………………………………………….………...I Table of contents………………………………………………………...…………..II List of figures and tables……………………………………………………….…..IV Acknowledgements………………………………………………………………….V Chapter I. Introduction…………………………………………………………….1 1.1 Objective of the dissertation…………………………………………………..1 1.2 Review of mergers and acquisitions in the UK……………………………….1 1.3 The framework of the dissertation…………………………………………….5

Chapter II. Business Combination Accounting………………………………….6 2.1 Acquisition (purchase) accounting…………………………………………….6 2.11 The fair value concept………………………………………………….7 2.12 The goodwill concept………………………………………………….8 2 .2 Merger (pooling-of-interest) accounting…………………………….8 2.3 Difference between pooling & purchase…………………………………….9

Chapter III. Accounting Policy……………………………………………………13 3.1 The historical regulatory framework over merger and acquisition accounting in the UK………………………………………………………………………13 3.2 The regulation of goodwill…………………………………………………..17 3.3 The recent adoption to IFRS…………………………………………………18 3.4 Summary of the recent accounting standards to business combinations in the UK……………………………………………………………………………19

Chapter IV. Illustration of the Accounting Methods……………………………21 4.1 Stage 1: The combination in Company A’s own records……………………21 4.2 Stage 2: Consolidating the individual balance sheets……………………….22 4.21 Merger accounting………………………………………………………22 4.22 Acquisition accounting…………………………………………………23 4.3 Comparing merger and acquisition balance sheets…………………………24 4.4 Eight months later……………………………………………………………24 II

Chapter V. Literature...
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