Bargain Purchase Gains in the Acquisitions of Failed Banks

In December 2007, the FASB revised accounting for business combinations and permitted firms to record a bargain purchase gain within current earnings at the completion of a business combination. Although the FASB contends that the new treatment improves the representational faithfulness of the acquirers’ current earnings, the ability to recognize a gain in current net income creates a contemporaneous opportunity for earnings management. We use a sample of 2009 FDIC-assisted bank acquisitions to examine the unintended and intended consequences of the revised standard. Despite finding evidence consistent with firms recognizing the gain to avoid reporting earnings declines, we find that the market values the gain similar to other transitory items. Overall, our findings provide support for the FASBs decision to recognize a gain associated with business combinations in current earnings.