Special Report: The Battle over Pooling of Interests

By Tie, Robert | Journal of Accountancy, November 1999 | Go to article overview

Special Report: The Battle over Pooling of Interests


Tie, Robert, Journal of Accountancy


In an effort to improve financial reporting and increase harmony between U.S. GAAP and international accounting standards, FASB introduced a controversial proposal that would require companies to reveal more of the costs associated with their mergers and acquisitions (M&A). However, some in the investment banking and academic communities argue that it may disrupt the M&A world and seriously weaken FASB's status as the primary accounting standards setter.

On September 7, FASB issued a two-part exposure draft, Business Combinations and Intangible Assets, which proposed eliminating the pooling-of-interests method of accounting for business combinations. The first part, which addresses the method of accounting for business combinations, is an amendment of APB Opinion no. 16, Business Combinations. The second, which supersedes APB Opinion no. 17, Intangible Assets, addresses accounting for intangible assets (including goodwill), whether acquired singly, in a group or as part of a business combination.

In place of pooling, the FASB recommended mandatory use of the purchase method, which, unlike pooling, requires companies to account for goodwill when they report on acquisitions.

Agreeing to disagree

In a press release announcing the issuance of the ED, FASB Chairman Edmund L. Jenkins said, "We believe that the purchase method of accounting gives investors better information about the initial costs of the transaction and the acquisition's performance over time than does the pooling-of-interests method."

After a comment period, which ends December 7, the FASB will take into account all comment letters and testimony as it discusses each issue during public hearings to be held early in 2000. "We estimate that our process will be complete and a final statement issued by the end of 2000," Jenkins said. If adopted as final, the statement would be effective for business combinations initiated after its publication.

But some observers think that relying on the purchase method will needlessly and significantly hinder the U.S. economy's current robust growth. The strength of that expansion, they say, is made possible largely by strategically sound business combinations for which the pooling method is an essential tactic.

A study of the pooling-vs.-purchase controversy, Valuing the New Economy: How New Accounting Standards Will Inhibit Economically Sound Mergers and Hinder the Efficiency and Innovation of U.S. Business, published by Merrill Lynch last June, said "the [purchase] accounting method itself would prove an obstacle to a merger that both parties are eager to consummate. As a result, the wave of consolidations that has enhanced productivity, encouraged innovation, and stimulated dynamism in the U.S. economy may notably decline."

Former FASB Chairman Dennis R. Beresford, now executive professor of accounting at the University of Georgia's Terry College of Business, told the JofA that, while he understands the reasoning behind such arguments, he cannot accept them. "The FASB believes that it should be neutral in its standard setting" he said. Beresford added that FASB doesn't consider "economic consequences" arguments during its deliberations, which do not focus on the achievement of economic goals.

Disclosure vs. earnings

Those critical of the FASB proposal point out that mandatory use of the purchase method can saddle a business with goodwill charges for intangible assets, such as intellectual property. In deals involving significant amounts of such assets, goodwill charges can erode earnings significantly, making a prudent deal look like a strategic error.

In completed deals that opponents of the proposed plan use to illustrate their point, goodwill charges would have given investors a negative view of the transactions' consequences. Ultimately, however, the deals proved economically and strategically sound, those critics say, because the assets they combined were properly valued, despite any premium over book value (i.

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