The value of international cross-border merger and acquisition activity rose by 47 percent from 1998 to 1999, up from US $541 billion to a record US $798 billion. United States' Generally Accepted Accounting Principles currently permit two mutually exclusive alternatives in accounting for business combinations. The first is purchase accounting. The second, pooling of interests, is the subject of proposed elimination. In this manuscript, the purchase and pooling methods are illustrated. Further, the potential impacts of the likely elimination of the pooling alternative are discussed, both in terms of standard setting implications and in terms of potential impacts on merger and acquisition activity.
Many corporate executives, financial analysts and investment brokers speculate that the elimination of the pooling of interests alternative to record mergers and acquisitions will severely reduce the number of such mergers and acquisitions. Why would the elimination of the accounting alternative cause a reduction in mergers and acquisitions? The purpose of this article is to explain the accounting alternative proposed to be eliminated and to link its elimination to the impact on mergers and acquisitions.
The Rationale Behind Current U.S. Accounting Rules
The booming world economy of the last few years has been accompanied by an increase in mergers and acquisitions. KMPG Peat Marwick reports that the value of international crossborder merger and acquisition activity rose by 47 percent from 1998 to 1999, up from US$541 billion to US $798 billion (KPMG, 2000). The ease of formation of new business structures through mergers and acquisition has generally been viewed as a positive factor for the economy. Thus, the reduction of the number of mergers and acquisitions could have negative consequences for the business economy, both in the United States and worldwide.
The use of an accounting alternative for recording mergers and acquisitions entitled "pooling of interests" has been widely used in business combinations for the last decade because of its favorable impact on earnings subsequent to the business combination. The standard setting body for accounting standards in the U. S., the Financial Accounting Standards Board (FASB), is proposing the elimination of the pooling of interests method as an alternative for recording business combinations. The elimination of this alternative thus might provide a negative incentive for the combination of business organizations.
United States' Generally Accepted Accounting Principles (GAAP) currently permits two mutually exclusive alternatives in the accounting for business combinations. These accounting methods are referred to as the pooling of interests method and the purchase method respectively. To better understand the effect of these methods on business combinations (mergers and acquisitions), a brief explanation of each method follows. The advantages and disadvantages of each method are also indicated.
The pooling method is based on the notion that two companies merge as equals. Either a new company is created or one company remains with the other becoming part of the remaining company. The concept underlying pooling is both previous entities retain their operating activities and identities in the same manner as before the combination. A recent example of such a combination is the merger of Daimler-Benz and Chrysler Corporation to form Daimler Chrysler. Under present United States' accounting standards recognized by the Financial Accounting Standards Board (FASB) as adopted from Accounting Principles Board (APB) 16 (APB, 1970), potential pooling candidates must meet requirements set forth by FASB (APB 16: Business Combinations) (see Figure 1). The staff of the Chief Accountant's office of the SEC reviews these criteria for business combinations that involve corporations under SEC jurisdiction. If the requirements are not met, the new entity must report under the purchase method (described below). …