FASB: 'Pooling of Interests' Misleads Investors
The Financial Accounting Standards Board (FASB) issued a proposal for
public comment that would, among other things, eliminate the pooling of
interests method of accounting for business combinations. The move is directed
at enhancing economic accountability and could act as a curb on questionable
transactions. As part of its public consideration of the issues, the Board
also will hold hearings on the subject early next year in New York and
San Francisco. Comments on the proposal are requested by Dec. 7.
"When two different accounting methods are used for what is essentially
and economically the same transaction, it is confusing to investors,"
said FASB Chairman Edmund L. Jenkins. "We believe that the purchase
method of accounting gives investors better information about the initial
cost of the transaction and the acquisition's performance over time than
does the pooling of interests method."
Under the purchase method of accounting, one company is identified as
the buyer and records the company being acquired at the cost it actually
paid. The excess of the purchase price over the fair value of the acquired
company's net assets is known as goodwill. Goodwill is then charged to
the company's earnings over time, but not, under the FASB proposal, for
more than 20 years.
Under the pooling of interests method of accounting, combining companies
just add together the book values of their assets. "In a pooling,"
Jenkins said, "an investor can't tell what price was actually paid
for the companies to merge nor can they track the acquisition's subsequent
performance." Jenkins noted that FASB also considered many other issues
in proposing to eliminate pooling, including:
The pooling method provides investors with less information-and less
relevant information-than the purchase method. It also ignores the values
exchanged in a business combination, while the purchase method reflects
It is difficult for investors to compare companies when they have used
different methods of accounting for what is essentially the same transaction.
Business combinations are acquisitions and should be accounted for as
such, based on the value of what is given up in exchange, regardless of
whether it is cash, other assets, debt, or equity shares. Because cash
flows are the same no matter what accounting method is used, the boost
in earnings under the pooling method reflects artificial accounting differences
rather than real economic differences, FASB said.
"We believe that the purchase method of accounting gives investors
a better idea of the initial cost of a transaction and the investment's
performance over time than does the pooling of interests method,"
FASB said when the potential change was announced in April (See NGI June 21).
The pending Dynegy-Illinova merger is being accounted for as a purchase.
The recent Energy East-CMP Group combination is a complete cash-out of
CMP common stock. However, many of the deals done over the last year or
two have used pooling of interest accounting.
Abolishing pooling of interests will make it more difficult for companies
to do unreasonable acquisitions, according to Sanders Morris Mundy analyst
John Olson. Under pooling of interests, an acquiring company could theoretically
pay any price for its target because all transaction costs were just added
together on the balance sheet. "There was never any ceiling on purchase
prices except those dictated by common sense." Olson said the impetus
for the FASB change came from the fact "there were so many deals being
done with poolings that don't really reflect the underlying economics of
the business. And there were a number of poolings that were being done
that would take a huge, one-time write-off at the time of the merger."
Public hearings on the proposed changes will be held over several months
next year. "We estimate that our process will be complete and a final
statement issued by the end of 2000," Jenkins said. If adopted as
a final statement, the standard would be effective for business combinations
initiated after the statement is published.
Copies of the proposal are available through the FASB Web site.
Joe Fisher, Houston