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July 1989

Is now the time to revisit accounting for business combinations?

by Dieter, Richard

    Abstract- It is believed the Financial Accounting Standards Board (FASB) should re-examine the rules and regulations associated with accounting for business combinations, especially in the areas of goodwill and pooling-of-interests accounting. Both are problem areas and both present challenges. While the issue of goodwill may be difficult to solve, a solution should be reached in the name of progress. In contrast, the concept of pooling-of-interests accounting is a concept that has no basis in economic reality and is in conflict with the primary-transaction-based approach that accountants typically use today. Additionally, the arguments that support the concept of pooling-of-interest accounting are not strong. It is recommended that this concept be completely eliminated by the FASB.

The question of revisiting accounting for business combinations typically revolves around "when" as opposed to "if" fundamental changes are needed. The present rules, embodied primarily in APB Opinion Nos. 16 and 17, are approaching their twentieth anniversary--an event many believe should never occur. Most recognize that these, rules were a convenient compromise, not rules of reason and logic. Their survival is only at the cost of shortcomings in financial statement presentation. Interestingly, the subject of accounting for business combinations was an early candidate for action by the newly formed FASB in 1973, and in 1976 a discussion memorandum was issued. However, the project was subsequently deferred indefinitely. The diversity of views as to the appropriate solution, and perceived difficulty in resolving the issues, are often cited as the rationale for the FASB failing to address this subject. Such logic is not persuasive, and users of financial statements are not well served by this inaction.

While this article focuses upon recent practical problems associated with the pooling-of-interests method of accounting, the FASB cannot realistically deal with this issue without addressing the entire area of business combinations including the primary nemesis--goodwill. The FASB may not yet be able to see a solution, but the marketplace, particularly in the international arena, is demanding one. The goodwill compromise of 1970, allowing a 40-year amortization period, is no longer deemed immaterial to many transactions because of: 1) regulatory pressure to use a shorter life in many situations; and 2) charges of an uneven playing field for U.S. companies that must amortize goodwill when they compete for acquisitions with non-U.S. companies that generally charge off goodwill to capital at acquisition.

Setting aside the conclusion that goodwill should be readdressed, the need for reconsideration of the pooling-of-interests accounting method more than jusifies revisiting the accounting for business combinations.

The following factors are cited as current reasons to eliminate the pooling-of-interests method:

1. The rules associated with pooling accounting have become so convulated that most accountants have difficulty reaching an appropriate conclusion when trying to resolve many practical issues.

2. APB Opinion No. 16 was developed at a time when the capital structure of companies was relatively simple. The new forms of securities and, more significantly, the agreements companies enter into with various shareholder groups, cannot be handled logically within the existing literature.

3. The pooling method remains one of the few areas of major consequence where the SEC and its accounting staff remain the de facto standard setter. Registrants and their auditors regularly feel it necessary to involve the SEC staff before reaching definitive conclusions on whether pooling-of-interests accounting is appropriate.

4. Elimination of the pooling method will improve uniformity when comparing accounting consequences of acquisitions with companies outside of the U.S., since few other countries have embraced the pooling-of- interests standard.

Faculty Premise Yields Unwieldy Rules

Analyzing a proposed business combination to determine whether it qualifies for pooling-of-interests accounting is an exercise that most accountants dread. The fear of missing some obtuse interpretation, whether formal or informal, by rule-setting bodies, and thereby setting the client up for a nasty surprise, is at the bottom of their concern. Most practitioners will readily admit that many of the pooling rules defy logic and have evolved by analogy rather than by applying the concepts of APB No. 16 that underlie the pooling approach. Thus, reaching an appropriate conclusion within the concept of pooling accounting is almost a happenstance.

A couple of examples will bring this point into focus:

1. Paragraphs 47c and 47d of APB Opinion No. 16 include provisions related to the reacquisition of voting common stock within two years prior to initiation and between initiation and consummation of a pooling-of-interests. Because the SEC believed these provisions were subject to varying interpretations in practice, it published extensive detailed rules covering treasury stock acquisitions to determine whether the acquired shares were "tainted." Included among the interpretations were various ways that the so-called "taint" could be removed. Subsequently, the SEC concluded that issuance of "tainted" treasury shares in a business combination, whether a purchase or a pooling, effectively cures any taint previously associated with such shares.

2. APB Opinion No. 16 contains prohibitions against the planned disposition of a significant part of the assets of the combining companies within two years after the consummation date, other than disposals in the ordinary course of business and elimination of duplicate or excess capacity. The SEC has expanded this provision by concluding that anything that is prohibited after the date of a pooling should be prohibited for the same period prior to the pooling. This interpretation seems at odds with the primary purpose of prohibiting asset dispositions following a pooling (i.e., the potential for selling off high value assets at a gain because the pooling method carries forward the acquired assets at historical cost rather than at current value).

Many of the larger CPA firms have developed extensive manuals citing interpretations, views, concerns, and pitfalls associated with the rules to achieve pooling-of-interests accounting. For example, our firm has recently published the seventh edition of a booklet on interpretations of APB Opinion Nos. 16 and 17. This book contains over 200 pages. This must say something about the ambiguity of the concept of pooling-of- interests to accountants. Soundly conceived concepts are more easily understood and interpreted shortly after adoption.

The rules frustrate companies seeking the use of pooling accounting. Because pooling is often viewed as critical to a particular transaction, it is not uncommon for the merger agreement to require that it must be accounted for as a pooling. Unfortunately, because many of the rules relate to past business transactions and events of the companies, there is no fix available to cure the inability to pool. CPAs are then put in the position of telling clients, "sorry, six months ago you broke a rule you didn't know existed, therefore you cannot have a pooling." The rules are also used as part of a company's anti-takeover strategy. If a company believes it would be less attractive if the acquiring company would have to follow purchase accounting, it may use the rules to make itself "non-poolable" for an extended period of time. This has a certain anti-competitiveness aura to it and does not seem consistent with the notion that accounting should provide a level playing field.

Another cryptic remark often heard is that pooling is a privilege you earn by following rules which are not always published and may have been set without due process. The illogic of such responses puts CPAs on the defensive and often damages carefully nurtured client relationships. All involved suffer as a result.

Impact of Business Affiliations and Stockholder Affiliations

Prenuptial agreements are in vogue in the 1980s, and marriages are more complicated than in the past. However, these complications do not compare to the complexities that have crept into the pooling arena as companies seek to combine their interests and go forward together as if they had never been separate entities from a financial reporting viewpoint.

Capital structures in the 1980s have become complex and sophisticated. Business affiliations and stockholder relationships have been created via a myriad of securities instruments. Evaluating the impact of these arrangements on pooling-of-interests accounting matters is extremely difficult, if not impossible. For example, should a company be prohibited from entering a pooling transaction through issuance of its regular listed common stock when it has two classes of common stock, one representing an unlisted super voting common stock which is immediately convertible into regular common upon sale but which is not otherwise registered? Should a company be prohibited from pooling simply because its preferred stock has the majority voting interest? Can a company which has a close working relationship with another company with some reciprocal stock agreements enter a pooling with that company?

One of the basic rules of pooling accounting is that the acquiring company offer to acquire all of the voting common stock of the company. Today we have securities issued by target companies that have many of the attributes of common stock. In these cases, the SEC has concluded that these securities must also be exchanged for common stock. The important question then becomes, "what is `essentially the same' as common stock?" This relatively narrow issue has created the need for several informal intrepretations, since many securities are designed to have a significant majority of attributes similar to common stock, yet have some differences that presumably create both an economic dysfunction and a price diferential. Definitive guidance has not been developed and, consequently, discussions with the SEC staff are necessary before proceeding with the transaction.

Pooling Accounting Rules Set by SEC

In recent years, the SEC has gone out of its way to support the private sector and the rule-making authority of the FASB, a policy most accountants heartily support. While at times the SEC has prodded the FASB to undertake certain projects and to consider its viewpoints on certain issues, for the most part the accounting rules coming out of the SEC in recent years have dealt with relatively narrow issues and matters where abuses were perceived. There is, however, one exception-- interpretations of APB Opinion No. 16 dealing with pooling-of-interests accounting. Further, the Chief Accountant's Office does not often issue SABs or other interpretative guidance on pooling-of-interests issues. Rather, pooling-of-interests accounting questions for registrants are handled on a case-by-case approach, and word of mouth is supposed to make these views available to the profession as a whole. Clearly, a CPA may be significantly embarrassed when he or she has concluded pooling accounting is acceptable and a question is subsequently raised by the SEC staff, responding that a previous ruling found that particular facet of the transaction unacceptable.

In fact, the Chief Accountant's Office of the SEC has become the de facto standard-setter for pooling-of-interests accounting. The FASB has been reluctant to delve into this quagmire and only on rare occasions has it published guidance, primarily through technical bulletins or consensus decisions of its Emerging Issues Task Force. While it is doubtful that the SEC would want to take on the responsibility of overturning APB Opinion No. 16, if the FASB takes up the project, the SEC would most likely support it.

Impact of International Competition for Merger Candidates

In today's global economy, cross-border acquisitions are much more frequent than at time APB Opinion No. 16 was issued. While there has been much discussion and many press reports on the different GAAP treatments of goodwill in the industrial countries, significant differences also exist as to: 1) the availability of the pooling-of- interests method of accounting; and 2) to the extent pooling accounting exists, the "rules" are substantially less complex than those existing in the U.S. Overall, elimination of the pooling-of-interests method in the U.S. would improve, but not totally eliminate, the existing accounting differences for business combinations among leading industrial countries. Addressing the accounting for goodwill would be the final step in reconciling the major differences in business combination accounting around the world.

More recently, the International Accounting Standards Committee (IASC), in connection with its project to reduce the number of alternative accounting principles presently permitted under its standards, focused on the area of business combinations. It has recently issued a comprehensive exposure draft on elimination of alternative accounting principles that, among other things, eliminates the use of pooling-of-interests accounting. This notion has also received the conceptual support of the SEC Chairman.


The title of this article asks a question. The answer is "yes." Accounting for business combinations should be readdressed and now is the time. Both goodwill and pooling-of-interests accounting are problems and both present unique challenges. The goodwill issue may be conceptually more difficult to solve, yet it is an issue that must be resolved if true progress is to be made. On the other hand, the concept of pooling-of-interests is an accountant-related concept that bears no relationship to economic reality and is at variance with the primary transaction-based approach used in most areas of accounting today. The conceptual arguments to support continuation of this form of accounting are weak. In almost all business combinations that are accounted for as poolings-of-interests, an economic event has taken place whereby one entity has acquired another. To not account for these very significant transactions at their economic value further erodes the credibility of the continuing financial statements. While effecting change is never convenient and many view no time as the right time to make a change, the accountant's fallacy of pooling-of-interests accounting should be eliminated as part of an FASB project to reconsider, in its entirety, the subject of accounting for business combinations.

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