FASB Pulls Plug on Pooling-of-Interests Accounting

The method, often used in tech mergers, will likely be eliminated by 2001.
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The Financial Accounting Standards Board decided Wednesday to eliminate an accounting method that has greased the way for major mergers and acquisitions in Internet and other industries. However, the decision, subject to additional comment and a final approval, was not made without a fight.

The FASB, the nonprofit organization that sets accounting rules for U.S. companies, unanimously voted in favor of eliminating pooling-of-interests accounting and treating all business acquisitions in the U.S. as purchases. Assuming the new rules are adopted, they won't take effect until at least a year from now.

This accounting method has played a major role in many business mergers and takeovers, including high-profile Internet deals such as

America Online's

(AOL)

acquisition of

Netscape Communications

and

Yahoo!'s

(YHOO)

proposed acquisitions of

GeoCities

(GCTY)

and

broadcast.com

(BCST)

. Pooling has not just been limited to Net stocks: It also helped the mergers that created

Citigroup

(C) - Get Report

and

DaimlerChrysler

(DCX)

.

"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," said FASB Chairman Edmund L. Jenkins in a statement.

The new rule, though, won't affect companies any time soon, because the FASB expects it to be implemented in late 2000, at the earliest. Companies who have already initiated combinations by that time won't be affected, even if their deals haven't closed.

A December invitation to comment, in advance of Wednesday's meeting, on plans to eliminate pooling of interests drew 140 letters from interested parties in the financial community: venture capitalists, accounting firms, investment banks and companies large and small.

That's no surprise, since the change could have a marked effect on any company thinking of acquisitions. At issue is how best to describe a merger of two companies in a financial statement. When companies account for a transaction through a pooling of interest, they can simply combine their financial results as if they had always been one unit. But if an acquisition is made through a purchase, the acquirer has to amortize goodwill -- the difference between the purchase price and the fair market value of the assets of the acquired company -- over many years and thus depress future earnings.

Based on responses from companies, the FASB will have to contend with debate over how to properly account for goodwill acquired in the course of a purchase.

In fact, though the FASB has already made some tentative decisions about changing accounting for goodwill, Jenkins says the comments it received on the subject have prompted the board to revisit treatment of goodwill. "I think we were impressed -- maybe not convinced, but impressed," Jenkins says, by a "pretty unanimous" lack of support for the board's current proposals. "I think that caught our attention," Jenkins says.

Eliminating pooling did have its supporters. A committee of the

Association for Investment Management and Research

argued that pooling doesn't faithfully represent premiums paid by the acquirer in a transaction. Purchase accounting also had the support of some established hardware-intensive firms, including

3M

(MMM) - Get Report

,

General Motors

(GM) - Get Report

and

IBM

(IBM) - Get Report

.

Arguing forcefully for preserving pooling of interests,

Sevin Rosen Funds

-- where

Compaq

(CPQ)

Chairman Ben Rosen is a founding partner -- urged the FASB not to pursue "the risky and potentially economically disruptive path" of eliminating pooling-of-interest accounting. The firm regards traditional accounting as irrelevant to high-tech companies. "Increasingly, hard assets that traditional accounting was designed to account for are just not important to measuring value," stated Sevin Rosen.

Though pooling of interest has been used a lot among high-tech companies, at least one of the letters reminded the board that this issue touches other companies too. Craig Jones, managing partner of

Ticonderoga Capital

, warned how pooling would affect the fate of the corrections management industry, where it has invested in

Cornell Corrections

(CRN)

. In the absence of any appetite in the public market for 10 to 15 companies in the corrections business, it makes sense to roll up the companies together before an IPO, Jones wrote. But without pooling rules, he said, "such combinations would not make sense for the seller."

"There is no doubt your proposed rules would slow down acquisitions both small and large and therefore make such combinations much more difficult," Jones wrote. "You would rob the U.S. of one of its strongest competitive advantages, the smooth and rapid combination of businesses."

But comments like those held no sway with the board. An FASB staffer made clear, in a presentation to the board before its vote, that it shouldn't make decisions based on what the consequences of new accounting procedures might be, including whether they might increase or decrease the number of transactions that get done.

Many companies, though, have to start thinking of how this ruling will affect the bottom line. Yahoo!, a company that is employing pooling to make acquisitions, will not make any "reckless" deals "just because the clock is ticking on pooling," says its president, Jeff Mallett. But he argues that if and when new rules are put in place, Yahoo! will be one of the few Internet companies big enough to do deals without getting hurt by purchase accounting.

"There will be a shorter and shorter list of companies that have the scale to do that, and we think we're going to be there," Mallett says.