Trade-Offs between Tax and Financial Reporting Benefits: Evidence from Purchase Price Allocations in Taxable Acquisitions

53 Pages Posted: 13 Feb 2015 Last revised: 19 May 2018

See all articles by Dan Lynch

Dan Lynch

University of Wisconsin - Madison - Department of Accounting and Information Systems

Miles A. Romney

Florida State University

Bridget Stomberg

Indiana University - Kelley School of Business

Daniel Wangerin

Wisconsin School of Business

Date Written: May 16, 2018

Abstract

Under U.S. GAAP, firms recognize assets acquired in business combinations at fair value. Similarly, in taxable asset acquisitions firms adjust the tax basis of assets to fair value. Managers can increase the present value of future tax savings by allocating a greater portion of the purchase price to shorter-lived assets than to goodwill or indefinite-lived intangibles. However, this tax planning strategy imposes a financial reporting cost because it reduces book income following the acquisition; all else equal, allocations to shorter-lived depreciable assets increase book depreciation expense whereas allocations to goodwill and indefinite-lived intangibles do not increase book amortization expense. We exploit the features of taxable asset acquisitions to investigate tradeoffs between tax and financial reporting incentives. We predict and find greater allocations to depreciable versus intangible assets when managers have strong tax incentives and weak financial reporting incentives. However, we also find that strong financial reporting incentives moderate the effects of strong tax incentives. These findings contribute new evidence to the literature on the importance of nontax costs in tax planning decisions.

Keywords: Book-tax tradeoffs; M&A; Goodwill; Tax Avoidance, Earnings Management

JEL Classification: M41, G34, H25

Suggested Citation

Lynch, Dan and Romney, Miles A. and Stomberg, Bridget and Wangerin, Daniel D., Trade-Offs between Tax and Financial Reporting Benefits: Evidence from Purchase Price Allocations in Taxable Acquisitions (May 16, 2018). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2563791 or http://dx.doi.org/10.2139/ssrn.2563791

Dan Lynch (Contact Author)

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States

Miles A. Romney

Florida State University ( email )

Tallahasse, FL 32306
United States

Bridget Stomberg

Indiana University - Kelley School of Business ( email )

1309 East Tenth Street
Indianapolis, IN 47405-1701
United States

Daniel D. Wangerin

Wisconsin School of Business ( email )

975 University Avenue
4104 Grainger Hall
Madison, WI 53706
United States

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