Even assuming that the reported book value (some $84 per share) of The Bear Stearns Cos. is overstated — because substantial asset write-downs have yet to be incurred — it seems apparent to most observers that the “true” book value is probably much closer to the reported figure than to the price JPMorgan Chase & Co. is paying. To be sure, JPMorgan is set to acquire the equity of Bear Stearns for about $2 per share. If that happens, this deal is a rare accounting phenomenon — a so-called bargain purchase.
Before discussing the accounting-treatment implications of the deal, there are some potential tax implications to consider. At this point, little information has been provided regarding the terms and structure of the deal: the press release describes a “stock for stock exchange” in which each share of Bear Stearns will be acquired in exchange for 0.05473 of a share of JPMorgan. So, without more information, the deal appears to be intended to qualify as a tax-free reorganization. If that’s so, the Bear Stearns shareholders will be precluded from recognizing, for tax purposes, the losses they realize on the exchange.
Under the tax code, specifically Section 354(a)(1), “…no gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are…exchanged solely for stock or securities…in another corporation which is a party to the reorganization….” In these cases, the exchanging shareholders will hold the shares they receive at the same basis at which they held the shares surrendered in the exchange (see Section. 358(a)(1)). As a result, a Bear Stearns shareholder — who holds the JPMorgan stock she receives at the same basis at which she held the surrendered Bear Stearns stock — will have to sell the JPMorgan stock received to record a deductible loss for tax purposes.
Alternatively, a Bear Stearns shareholder could sell her stock before the merger. In such cases, an investment of the sales proceeds in JPMorgan stock should not, because of all of the conditions that must be satisfied before the merger can proceed, run afoul of the wash sale rules. The stock of Bear Stearns, the sale of which will produce a loss, and the stock of JPMorgan should not, at least until the date on which the shareholders approve the merger, be regarded as “substantially identical” for purposes of the wash sale rules.*
Accounting for a Bargain Purchase
Accounting for the transaction under new fair-value rules presents other interesting considerations for deals in general. In December the Financial Accounting Standards Board promulgated new guidance with respect to the accounting for business combinations (see FAS 141(R)). That pronouncement defines a business combination as a transaction or other event in which an acquirer obtains control of one or more businesses. It seems clear that the proposed transaction involving Bear Stearns and JPMorgan will constitute such a business combination, and therefore must be accounted for using the acquisition method. Under this method, as of the acquisition date, the acquirer recognizes the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree (which remains outstanding). The acquirer is instructed to measure these items at their acquisition date fair-market values.