The Financial Accounting Standards Board (FASB) issued aproposal for public comment that would, among other things,eliminate the pooling of interests method of accounting forbusiness combinations. As part of its public consideration of theissues, the Board also will hold hearings on the subject early nextyear in New York and San Francisco. Comments on the proposal arerequested by Dec. 7.
“When two different accounting methods are used for what isessentially and economically the same transaction, it is confusingto investors,” said FASB Chairman Edmund L. Jenkins. “We believethat the purchase method of accounting gives investors betterinformation about the initial cost of the transaction and theacquisition’s performance over time than does the pooling ofinterests method.”
Under the purchase method of accounting, one company isidentified as the buyer and records the company being acquired atthe cost it actually paid. The excess of the purchase price overthe fair value of the acquired company’s net assets is known asgoodwill. Goodwill is then charged to the company’s earnings overtime, but not, under the FASB proposal, for more than 20 years.
Under the pooling of interests method of accounting, combiningcompanies just add together the book values of their assets. “In apooling,” Jenkins said, “an investor can’t tell what price wasactually paid for the companies to merge nor can they track theacquisition’s subsequent performance.” Jenkins noted that FASB alsoconsidered many other issues in proposing to eliminate pooling,including:
The pooling method provides investors with less information-andless relevant information-than the purchase method. It also ignoresthe values exchanged in a business combination, while the purchasemethod reflects them.
It is difficult for investors to compare companies when theyhave used different methods of accounting for what is essentiallythe same transaction.
Business combinations are acquisitions and should be accountedfor as such, based on the value of what is given up in exchange,regardless of whether it is cash, other assets, debt, or equityshares.
Because cash flows are the same no matter what accounting methodis used, the boost in earnings under the pooling method reflectsartificial accounting differences rather than real economicdifferences, FASB said.
Public hearings on the proposed changes will be held overseveral months next year. “We estimate that our process will becomplete and a final statement issued by the end of 2000,” Jenkinssaid. If adopted as a final statement, the standard would beeffective for business combinations initiated after the statementis published.
Copies of the proposal are available through the FASB Web siteand through its Order Department, 401 Merritt 7, PO Box 5116,Norwalk, CT 06856-5116. Or call (203)847-0700, Ext. 555.
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