The Assault On Pooling Accounting For Business Combinations Continues

The Financial Accounting Standard Board ("FASB") recently announced that it will eliminate pooling of interests as a method of accounting for business combinations. The decision was unanimous.

Regardless of the legal classification of an acquisition, the accounting for a business combination is either the purchase method or the pooling of interests method. The purchase method records at cost the acquired assets less liabilities assumed on the corporate records of the acquirer. The difference between the cost and the sum of the fair values of the tangible and intangible assets less liabilities is recorded as goodwill. The goodwill is then amortized over its useful life and such amortization is recorded as an expense of the acquirer thereby reducing reported profits in future years.

The pooling of interests method accounts for a business combination as a uniting of the ownership of the two businesses. The recorded assets and liabilities of the acquired business are carried on the books of the acquirer at their recorded amounts, without recognition of goodwill arising out of the transaction. However, the pooling of interests method can only be used in certain limited circumstances, i.e. basically those acquisitions accomplished solely through the issuance of common stock and not involving cash or other assets. The major benefit of pooling of interests method of accounting is that the goodwill is not amortized in determining profits and losses of the business.

High technology companies are particularly opposed to the change. The acquisition of a high tech company usually results in a substantial portion of the purchase price being allocated to goodwill, if purchase accounting is required. This recognition of goodwill will depress future reported earnings of the combined companies. Furthermore in high tech companies the life of goodwill is short and so the effect on reported earnings due to the amortization may be significant. To the extent that the market price is a multiple of earnings, the value of the combined companies may not be enhanced by the acquisition. This accounting result may adversely affect the prices paid for acquisitions as well as deter growth through acquisitions.

This change in accounting approved by the FASB will become effective for business combinations initiated after the FASB issues final standards, which is expected to be in late 2000. The FASB intends to issue a formal proposal for comment in the third quarter of this year.

Pooling of interests method is principally an American accounting method and is not a generally acceptable accounting method in European and many other countries.

The decision of the FASB will not affect combinations within a consolidated entity such as a merger of subsidiaries. Its application to swaps and exchange transactions has not been determined at this time.

This action is reminiscent of the proposal by the FASB in 1994 to change the rules for accounting of employee stock options by making the grant of the options an expense to be reported in the statement of income. This action was highly attacked by the computer industry and others. As a matter of fact, the Senate passed an advisory resolution opposing the change. As a result, the accounting rules were modified before adoption to provide for such reporting in a footnote. History may repeat itself with respect to the FASB’s decision to eliminate pooling of interest accounting.