An Empirical Analysis Of China’s Listed Firms’ Choices Of Accounting Methods For Business Combinations

The accounting for business combinations has been a controversial issue in theaccounting field. China’s new accounting standards set a dual structure of twomethods’ co-existence after FASB and IASB abolished the pooling-of-interestsmethod successively. At the present stage, whether it is appropriate to use the poolingmethod in China has become an important theoretical and practical issue. To answerthis question, investigating firm’s motivation in choosing different accountingmethods and analyzing its rationality will make a great difference. Western economictheories argue that the main factors affecting a firm’s accounting methods choosingare management’s compensation, debt covenant and political cost. In the light ofChina’s special institutional background, these factors will lead to results which aredifferent from the western literatures. In addition, China’s financing and regulatoryenvironment will cause firms’ choosing between the two methods and take in incomemanagement in order to avoid delisting. Therefore, we uses the data of all A sharelisted companies in China during the year2010to2011to analyze the influences ofmanagement’s compensation, debt covenant cost (leverage), size and delistingpressure of a firm on its purchase-pooling choice. The findings are summarized asfollows:Management compensation and political cost are significantly related to theaccounting method choosing. The higher the compensation is, the more likely themanagement will use purchase method. The reason may lie in that the management’scompensation is usually related to firm’s size, so managers tend to acquire otherfirms outside the group in order to expand the scale of the firm. Firm’s size ispositively related to the pooling choice. One reason may be the consideration ofdecreasing political cost by recognizing less value of assets. Another possible reasonis that the large firm is more likely to consolidate within its group for the purpose ofintegrating the group’s resources. We divide the sample by its ownership nature, andfind that the regression results of the state-owned group sample are in accordance with those of the all firms’ sample. Larger firms have more pooling transactions andhigher management’s compensation is accompanied by more purchase choices. Onthe other hand, in the counterpart group, we find no association between all thefactors and the accounting method choosing.Leverage and delisting pressure have no significant association with thepurchase-pooling choice. Possible explanations are firms have other means such asrelated party transactions to manage the income, and do not have to use theaccounting choices of business combinations.In summary, in the practical use of the two accounting methods for businesscombinations, firms do not have motivations for income management. Most firmsuse pooling method to solve the historical problems and integrate the resourceswithin the groups. And firms choose purchase method to expand and become largerand stronger. One thing noticeable is that the management may have the motivationto purchase firms for their own interests.The above findings indicate that the purchase and pooling methods set by thenew accounting standards are suitable for the conditions of China. Thepooling-of-interests method is appropriate for solving the historical problems andintegrating within the group. At the present stage, the dual structure of accountingtreatments for business combinations is rational.