Valuation of Goodwill During Mergers and Acquisitions Comparison - Accounting Assignment Help

Assignment Task

Introduction
The owners of the companies which are being merged introduce the companies’ net assets to a company which is termed as combined company after the merger, in exchange acquiring the ownership titles to the company where in the activity is continued after merger. Each of the shareholder participation in exercising control of the company depends on the conditions of the merger, discussed previously and incorporated in the merger plan.
The number of new stocks that is provided to the prevailing stockholders which is acquired/ merged with the other is called the exchange ratio and is dependent on the value per share of the merging companies which was previously determined. Therefore, to determine the exchange ratio it is important to know value of shares and value of ownership titles transferred. The method of valuation of companies which are being merged is not been specified explicitly and is left to the choice of individual judgement of owners and boards. Hence, all commonly known methods can be considered appropriate for the purpose of determining the exchange ratio.
In the case of the companies undergoing mergers and acquisition, the net asset value method, income methods, as well as multiplier and market comparison methods are the most frequently used method of valuation. Under these valuation methods, the ownership titles value may be significantly influenced by the net financial result disclosed in the financial statement. In the net asset value method, the entities value is the total value of net assets and are equal to equity, i.e. the total capital provided by owners which includes shares and reserve capital, along with capital generated during its regular operation (net financial result). The income method provides a valuation method based on future anticipated economic benefits as a results of business operations, i.e., company financial results or cash flows discounted to present value. The market comparison method (multiplier) considers factors such as P/E (price to earnings) ratio and the rate of dividend issued by companies which have similar characteristics. Therefore, ownership title value for determining the exchange ratio depends on the entity’s financial result per share, and/or the P/E ratio.
As a result of introducing net assets to the acquiring company at fair value by the owners of the acquired company and receiving ownership titles in exchange to the acquiring company, a positive or negative goodwill is created.

Literature Review
The mergers and acquisition which are accounted by the method of ownership title exchange and by alternative methods like the acquisition of ownership titles from the initial owners differ significantly. (Jindra and Moeller, 2011) stated that the acquirer companies which transfer their ownership titles during mergers and acquisitions manipulate the financial result. However among the which accounted for the acqusitions in cash, no significant statistical correlation in manipulating the financial result was found.
According to Agency theory, (Bou?ková, 2015), relys on the very fact that one party is performing something on the behalf of another party. The research investigates the link between managers and investors in the case of the reaction in the share price in relation to the treatment of goodwill (Farinha and Miranda, 2003).
According to (Wong and Wong, 2005), the previous practice of amortizing goodwill on a yearly basis prevented the asset from inflating in its book value. With in the impairment regime the yearly amortization and a test for impairment companies should be constructed instead, which meant that the goodwill could inflate the book value for years before it would be impaired.
(Knauer and Woehrmann, 2012) also reported that manufacturing companies may be made with personal incentives such as bonuses in mind. As per the author companies with performance based bonus schemes in which managers have been recently changed are more likely to do large impairments on assets such as goodwill in the beginning tenure. The authors add that firms with historical acquisitions where the same management that made the acquisition still has a key role in the firm, is less likely to impair their own acquisition as they try to save their own appearance and not to be recognized for a failed investment.
According to (Spasi?, 2012) research whether the changes in fair value measurement affected the accounting information provided. It was tested whether good will of manufacturing companies affected share prices. The results suggested that share prices were negatively affected when a firm is recording impairment. However, the market did not react as heavily to manufacturing companies when it came to smaller firms compared to larger firms.
(Arif, 2015) noted that the companies which account for the mergers using ownership titles before the merger/ acquistion takes place, influence the increase of market share price, which later translates into transferring a lesser number of shares to the shareholders of the acquired/merged company.
Similarly, the research study into the working capital of merging companies conducted by (Entezarkheir and Sen, 2016) showed that statistically, significant relations exist only within the group of companies accounting for mergers and acquisition based on ownership titles.
(Daitchman, 2017) following other authors, concluded that negative goodwill can be used for financial result manipulation to protect against a decrease in the financial result or a net loss. The research also considered negative goodwill recognized because of the merger. Negative goodwill is usually called as ‘bargain purchase’ and it results in the increase of the company financial result post-merger.
(Kulil, 2017) examined the impact the manufacturing companies has on accounting and valuation of the goodwill. It was found that estimation of goodwill based on fair values led to inflated goodwill balances. (Kulil, 2017) further explained that the reason why managers were reluctant to impair goodwill was that in an impairment would be like the managers admitting that they had overpaid for the acquisition the firm made.
(Falson, 2019) discussed the complexity of the goodwill in manufacturing companies, for example the adoption of a discount rate to translate the future cash flows to their present economic equivalent. In contrast to the findings of (Falson, 2019), other papers have criticized the management of manufacturing companies. If this is not done properly, the valuation of goodwill is questionable.
(Kwon and Ye, 2019) argues that the treatment and accounting of goodwill is one area in which managers are given an opportunity to act at their discretionary, which means that managers acts according to their own will. (Kwon and Ye, 2019) further argues that investors do not seem to be able to anticipate the manufacturing companies.
(Falson, 2019) found a positive correlation between equity valuation and disclosed goodwill. It indicates that a positive goodwill is correlated with the additional benefits resulting from the business merger and acquisition. There are studies which explain the behavior of equity value (market values) as result of disclosure of the plan to merge and therefore, the anticipated goodwill.
According to (Garcia, Lucena and Gomes, 2020) the effect of goodwill costs since previous authors mentioned, found goodwill costs to be statistically significant. The research explains the term associated as if there exists a major statistical correlation between the variables, in this case if there exist a significant correlation between goodwill costs and a firm’s share price.

Research Gap
Most research studies into the impact of disclosed goodwill upon the post-merger company image were conducted in the United States, in UK there is a lack of research on this subject.
The criticism brought forward in previous research makes it interesting to compare and see if the manufacturing companies regime is the best way to treat goodwill. If it is harder for investors to trust the reported numbers of the manufacturing companies regime compared to the tech companies, it means that there would be a reaction on the stock market (GERBAUD and YORK, 2007).
There have been different research papers discussing both the relationship between goodwill and share prices as well as the change between tech companies and manufacturing companies regime. The difference between previous research and this research is that this research uses another model than other papers within this subject, to see if the results will differ from the previously found evidence within this area. The variables which are used are from existing literature, however the blend of these variables are not tested in the past. Furthermore, the time period chosen for the sample is also different.
Research QuestionsRQ1: How the goodwill disclosed in the result of a merger depends on the acquiring company’s costs allocated in assets.
RQ2: How the goodwill disclosed in the result of a merger depends on the acquiring company’s operating results.
RQ3: How association between goodwill costs and asset, liabilities, income is not different between the tech companies and the manufacturing companies?
Research ObjectivesTo test the association between goodwill costs with share price, to see if the stock market had any reaction to the tech companies or manufacturing companies of goodwill.
To explaining that there is an association between how the goodwill costs are treated and the share price, hence the industry sector either the tech companies or manufacturing companies do affect the share price

Hypotheses
To be able to answer the research question, following hypothesis shall be considered.
H1: The goodwill disclosed in the result of a merger depends on the acquiring company’s costs allocated in assets.
H2: The goodwill disclosed in the result of a merger depends on the acquiring company’s operating results.
H3: The association between goodwill costs and asset, liabilities, income is not different between the tech companies and the manufacturing companies.

Research Methodology Quantitative approachTo conduct the research, prior scholars (Fischer, Rodwell and Pickering, 2021) had helped laid the foundation of the method. The authors have proposed a methodology in which variables and proxies are useful in a quantitative approach of studying goodwill and its impacts. That framework will be used by the research to define which data to collect and how to improve the hypothesis.
If the firms included in the sample presents their financial reports in other currencies than UK (British Pound) for comparability reasons they will be converted to UK Pound when carrying out the analysis.
The analysis will be conducted as follows. The sample will be run through the regression model where the sample is divided into two periods, one for the tech companies regime (TECH) and one for the manufacturing companies regime (MANUF). The data allocation to each period is done by using dummy variables.
The multiple regression will be run on the sample which would contain about 500 individual firm. Based on this firm- year observations will be calculated. The result will be analyzed after the running the regression. The p-values will be examined to observe the significance of each of the independent variable on good will
Methods Used- Net asset value methodPurchase method: Goodwill(in intangible assets) or negative goodwill (in liability accruals)
The companies selected which have undergone merger/acquisition will be using the purchase method. The purchase method is the most used method in UK and US business combinations. The research into this topic is also carried out by (Moro Visconti, 2019).
Subsequently, companies which revealed positive goodwill (in intangible assets) or negative goodwill (in liability accruals) in their financial statements because of the merger will be selected.

Interest method: No goodwill will be created (either positive or negative)
In the case of mergers and acquisitions of entities, in which no goodwill will be created (either positive or negative) the method used to account for the combination could be the pooling of interest method or the combination occurred between companies under shared direct control, where the acquired company had been previously founded by the acquirer (Ashby, Chyz, Myers and Whipple, 2020).
The test of the non-linear form of the regression function – squares of variables will be performed. The research will also involve a regression analysis, as well as the verification of the significance and correlations between the independent variable and dependent variables. The results of all the regressions and correlations will be analyzed.

Data Collection
Sampling of the research data will be conducted on UK FTSE 100 & Dow Jones U.S. Index, containing minimum of 500 firms for 10 years each from 2011 to 2020. The data will be collected manually from the annual reports of the firms. The research will exclude firms that do not carry any goodwill in the balance sheet among the data collected. Further, the research will eliminate the data from the years with incomplete data in terms of financial data and share prices. Also, firm years may also be excluded if the stocks are not being traded on the public stock market for the period of 2011-2020. Companies that would have had their initial public offering later than the 1st of January 2020 will also be eliminated.
Secondary Data Sources which will be considered are Yahoo Finance, annual report, UK FTSE 100 & Dow Jones U.S.
Sample SizeThe research sample would consist of high tech/ software and manufacturing companies operating between the years 2011 to 2020 of UK and USA. The firms of United States of America will be considered because most of major software and high-tech companies are headquartered or based out of USA. Also United Kingdom is considered as it has a major base of manufacturing companies with historical data available along with substantial number of high-tech research-based companies.
The sample would consist of 500 acquiring companies or companies which underwent mergers. In the final database there will be at least 10% (50) firm which underwent mergers and acquisitions revealing positive goodwill and 10% (50) firm revealing negative goodwill.
Data AnalysisTo verify the hypothesis formulated in the research, the regression analysis will be used with the support of the SPSS statistical software. A regression model will be formulated, the significance and correlations between the explanatory variable and the dependent variables will be examined for tech companies and manufacturing companies separately.
Statistical toolsStatistical tools which will be used include linear regression analysis, normality of residual distribution test and nonlinear regression function test. To carry out regression goodwill (GW) will be the dependent variable. It will be calculated separately for positive and negative goodwill. GW = ln(goodwill)
Regression AnalysisFirst Regression AnalysisAs a dependent variable goodwill (GW) will be considered. The Explanatory variable /Independent variables will be prepayments (ACC) and operating result (ROA)
The ACC provides information on the proportion of costs (short-term prepayments) incurred one year before the combination which will be not accounted for in the financial result.
The ROA (operating result) is expected to clarify if the disclosed goodwill depends on the operating profit or loss.
Aim of the analysis is to examine if the goodwill (positive or negative) disclosed after a business combination is sensitive to the manipulation of the financial result in the acquiring company in case of tech and manufacturing companies.
Second Regression AnalysisIn the regression model, goodwill (GW) will be the dependent variable and seven different independent variables to test which variables explain the variation in goodwill will be considered for both tech and manufacturing companies.
The aim of the regression analysis is to examine different effect of asset, liabilities, income on goodwill in case of tech companies and the manufacturing companies.

The regression for the research is as follows: Regression model (2011-2020)
The independent variables that will be tested for the hypothesis are assets, liabilities and income. The REV and NETIN variables will be included to see if the impact of each of the variable on goodwill. TL, TA ,EARN , ?EARN and ROE, will be included since all of them are found to be related to good will in the past.
Dependent variable which will be used in regression modelGW (i, t) The good will as recognized in the balance sheet of firm i, in period t.
Goodwill cost is defined as the tech companies and/or the manufacturing companies cost. Goodwill costs will be divided into two different variables, goodwill of tech companies and goodwill of manufacturing companies
Independent variables which will be used in regression model:TA (i, t) Total assets of firm i, for the period t; TL (i, t) Total liabilities of firm i, for the period t; ROE (i, t) Return on equity for firm i, period t; REV (i, t) amount of revenue generated by firm i, for period t; NETIN (i, t) NETIN of firm i, period t; EARN (i, t) Amount of earnings recognized by firm i, period t; ?EARN (i, t)Changes in earnings recognized between year of firm i, from period t-1 to t; TECH(MANU) An indicator variable which equals 1 for observations occurring in the tech companies period(manufacturing companies period) and equals 0 if not
ROE is a performance-based variable. ROE is used to measure the firm’s utilization of its equity and how it can turn the equity into returns.
The earnings of the firms, and the change in earnings will be added as two separate independent variables. In the previous researchers’ earnings and change in earnings are included in return models. Both variables are examined in similar return models to have an impact on goodwill.
The research expects to gain results explaining that there is an association between how the goodwill costs in tech and manufacturing companies are treated in relation to the seven independent variables considered. The research argues that goodwill costs under an tech companies does not provide much information to investors, instead this simply adds more noise in an annual report.
LimitationsSince the implementation will occur in 2021 the research has to go back some years to collect the necessary data. This will cause issue where the data needed will be not available in most databases, leading to manual collecting of the data. Because of this there are chances that I will be not able to collect all data in one database, instead I will have to collect the financial information from Retriever Business, and mainly annual reports. The information of the goodwill can be collected from Yahoo Finance.

The need to collect data from different sources increases the risk of mistakes as data may be presented differently on different sources. However, whenever there is doubt it is observed that the authors have used the annual report as the main tool to resolve potential issues.

Another limitation of the research is the narrow setting. The research is aware that the setting examined is a narrow group of companies (including only tech and manufacturing companies based out of UK and US) in a special setting with a certain set of laws and governing rules. Hence the outcome of this study may not be reproducible in other settings if attempted.

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