Effects of Accounting, Taxes and Regulations on Merger and Acquisitions - Research Paper Example

Mergers and Acquisitions Analysis Since the recent economic recession and the need for capital for smaller companies, mergers and acquisitions has become a common practice to safeguard the place in the market as well as competitiveness. Most of the smaller companies are eager to join in with other bigger ones so as to create strength of capital which is referred to an acquisition while the merger is the combination of two or more than two companies to create a much strong one. (Investopedia) The mergers and acquisitions have several effects on the accounting, legal procedures and tax system of the company which are analyzed below. Effect of Accounting on Mergers and Acquisitions A merger and an acquisition affects the accounting practice of the company with respect to their cost reduction, revenue enhancement and risk management etc. Cost reduction: Cost reduction is one of the most important factors of motivation for companies which are looking for mergers and acquisitions. It is the objective of numerous medium and small sized organizations, as they look to reduce the cost per unit through the enhancement of economies of scale. It makes more simpler for the companies to enter and gain access to cheaper markets when they look for purchase in bulk as their requirement is also enhanced. Cost reduction also includes the reduction of risk costs as it makes the association less exposed to risks. (Schubert) Revenue enhancement: The main factor that leads to a merger and acquisition is the motivation towards revenue enhancement. The expectation to sell the product to a larger base of consumers by an increase in the distribution channels of the combined entity. (Schubert) Some companies also embark the use of product diversifications as they merge with other organizations in different geographical locations where they have no access previously such that their market becomes available in other places as well. It is also argued that the revenue enhancement is a more difficult aspect to realize compared to that of cost reduction as only a few firms are able to expand in new market and procure further distribution channels. Risk Management: Companies in quest of mergers and acquisitions are always looking to reduce the risk that they bear in the market environment by adding up further capital, means of expansion and steady growth which could secure their place in the market. There is a great impact of risk management on the merger and acquisition transaction as the firms that are looking to merge share the burden of each other and can put forward more capital input together, therefore sharing the risk of capital exhaustion. Since the companies together have better strength of payback, they are able to acquire more loans in time of need as their payback capacity also enhances through their combination. The mitigation of risk is the prime factor of merger and acquisition as entities that merge or acquire other entities have access to more resources where they can handle more pressure at difficult time. Effect of Taxes Apart from cost reduction, risk management and revenue enhancement there is a great impact of taxes and the benefits arising from taxes as mergers and acquisitions bring shields, synergies and weighted average cost of capital etc. Taxes bring a lot of benefits to the merged entities and provide great tax advantages which are discussed below. Tax Shields: Tax shields refer to the tax benefit that flows to the entity in form of a deduction of the taxable income of an entity such as the interest expense on debt of a company which can save the company some cash outflows. When a profit making entity merges or acquired an entity which has some accumulated losses in the past, they are able to utilize the benefit from the tax shields. The profit making entity can use the accumulated losses as set off against the future profits of the already profit making entity as the loss making entity will not be able to set off their loss against their own prospective profits. This will enable the combined entity to gain the benefits of a tax shield. (Economics or Reasons of Mergers) Synergies: Synergy is the benefit of a combined unit’s greater value than the value of individual units that are summed together. In easy words, it can be referred to as 1+1=3 as two entities together may produce better results compared to the sum of results of individual entities produced individually. Due to the synergy, the combined entity will be able to obtain and service a greater amount of debt as they would be able to service alone. This will enable an increased amount of borrowing and hence a greater interest expense which will enable greater tax shields to the entity which will enhance the wealth of the shareholders. Weighted Average cost of capital: The weighted average cost of capital may also have effects on the tax practices of a merged or acquired entity. The weighted average cost of capital can be employed in order to decrease the taxable income of an entity. This can be done through employment of debt financing in place of equity financing that will reduce the taxable income by reduction in the weighted average cost of capital and thus leaving a fair amount for the shareholders. Legal There are some legal impacts of merger and acquisitions which affect the combined entity as a whole. These impacts are discussed below: Corporate Organization and Ownership: A legal aspect of the merger or acquisition is that the entities must be validly existing and duly organized. There is a huge impact of the organization structure and its ownership on the merger and acquisition activity. If the organizations which are looking to form a combination are companies having a share capital then their share capital will be combined with each other’s share capital. It also depends on the kind of business combination that what kind of corporate structure the merged or acquired entity takes after the business combination. The rights and entitlements of the shareholders are also affected by the business combination as it depends on the size of the entity formed. Compliance of law: When there is a merger or acquisition, some additional compliance of law also comes into play as a merged or acquired entity has to carry out more legal requirements compared to an individual entity. The seller and the buyer in case of acquisition and both the combining entities in case of merger should be in compliance of the law such as the rules, government regulations and effective ordinances etc which are at the time of the merger in affect. The entities are required to make all the filings on time, that are required to be made under any laws governing the state where the merger is taking place and all the licenses, permits, approvals and certificates are obtained prior to the business combination. (Vines) Litigation Risk: There are also some litigation risks prior to the merger and acquisition which largely affect the merger and acquisition process. The litigation risks can be that of the outstanding business issues that of accounts payable, receivable etc of the merged entities, the issues relating to benefits of the employees of the prior merger and acquisition organization and apart from these there is a risk of monopolization as prior to a merger there will be a requirement to obtain approvals from the government in respect of the formation. (Find Law) References Economics or Reasons of Mergers. (n.d.). Retrieved from Knoeledge Base: http://www.mbaknol.com/management-concepts/economics-or-reasons-of-mergers/ Find Law. (n.d.). Retrieved from http://library.findlaw.com/2005/Jul/22/186428.html Investopedia. (n.d.). Retrieved from http://www.investopedia.com/terms/m/merger.asp Schubert, M. (n.d.). Retrieved from Mergers and Acquisitions Vines, L. D. Mergers & acquisitions of franchise companies. American Bar Association. Read More