ASB has decided that the pooling-of-interests method of accounting for business combinations should no longer be permitted and is in the process of developing a proposed standard that would eliminate the pooling option. It is not likely that the new standard will be effective in less than a year or so. In the meantime, it would not be unsurprising if there were a rush to complete business combinations using the pooling approach to avoid having to record goodwill.
Salomon Smith Barney's Financial Strategy Group recently released the results of a study on the extent to which the market distinguishes between business combinations accounted for as poolings versus those accounted for as purchases, where goodwill is recorded as an asset and amortized against future earnings. The study sought to answer whether in a purchase transaction, the price earnings multiple is adjusted to negate the goodwill charge because it has no effect on cash flow.
Specifically, the Salomon Smith Barney's objective was to find answers to the following questions: Does the choice of purchase or pooling affect firm valuations?
Salomon Smith Barney's conclusion:The evidence from stock market valuations and from stock market reactions to transaction announcements strongly demonstrates that purchase accounting does not adversely affect firm valuations.
How do differences in goodwill and its amortization affect cash flow and price/earnings multiples?
Salomon Smith Barney's conclusion: Balance sheet goodwill has no adverse impact on cash flow multiples. Price/earnings multiples expand sufficiently to offset income statement amortization, leaving stock prices unaffected.
Does the rate of amortization affect valuations? …