Financial Statement Analysis, 5th Edition

CHAPTER 10Mergers‐and‐Acquisitions Accounting

Business combinations attract vast attention beyond the investment world for a variety of reasons. Consolidation of smaller enterprises into larger ones often produces economies of scale and scope that contribute to economic efficiency and growth. In some instances, though, the antitrust authorities seek to block a proposed merger or acquisition, alleging that it will cause an industry to become overly concentrated. That could enable the combined company to extract monopolistic profits, a detriment rather than a benefit to the economy. Fees from advising on M&A transactions are an important revenue source for investment banks. Hollywood occasionally puts the drama of takeover battles onscreen.

Investors often attribute value to companies, over and above what is justified by their earnings prospects and risks, based on their perceived attractiveness as acquisition candidates. In these transactions, the acquirer typically pays a substantial premium to the target company's prevailing share price. The acquiring company's shareholders can benefit when an M&A deal genuinely creates synergy, but they must be on guard against corporate managers' efforts to produce the illusion of value creation through financial reporting gimmickry.

Inflating reported earnings in the context of M&A has a long history. Pooling‐of‐interests accounting was a favorite device of 1960s conglomerates, which were popularly described as operating on the 2 + 2 = ...