Trend Toward Cash Accounting Mitigates FASB Plan to Drain Pooling

In Silicon Valley, companies and analysts are busy plotting ways around the proposed change.
Author:
Publish date:

SAN FRANCISCO -- Beneath the cool reception to the

Financial Accounting Standards Board's

proposal to eliminate pooling-of-interest accounting seethes another hot topic: How relevant are FASB decisions to reading financial statements?

FASB invited public comments Wednesday, an act that has at times triggered a flood of opposition. If adopted, the once-popular method of accounting for acquisitions, especially those in

Silicon Valley

, will be outlawed by the year 2000. Surprisingly, the FASB pronouncement elicited more comments on how companies and analysts are planning to get around the decision's impact on financial statements than on whether they agree with it.

"Companies have been expecting this for a while and are increasingly looking beyond the GAAP financials to the fundamental economics of deals," says Michael Lloyd, M&A principal in

KPMG's

Silicon Valley office.

Pooling-of-interest accounting, which adds together the book values of the combining companies, originated in deals where the acquired company had more value in its intellectual property -- usually a new technology or coveted patent -- than it did on its balance sheet. Unlike the standard method of purchase accounting, pooling didn't require the amortization of goodwill or the difference between the purchase price and net assets of the acquired company.

Over time, though, many technology companies became more liberal in their use of pooling accounting to avoid amortization costs that weigh down profits. In announcing its proposal, FASB said the method confuses investors. "In a pooling, an investor can't tell what price was actually paid for the companies to merge nor can they track the acquisition's subsequent performance," FASB Chairman

Edmund Jenkins

said in a statement.

Earlier this year, when word first surfaced that the FASB had pooling accounting in its crosshairs, M&A experts and companies alike voiced their concern that merger activity would be adversely affected. Since pooling doesn't affect a combined company's income statement, many companies strongly favored it over purchase accounting. The FASB first officially announced its intention to drop the ax on pooling in April.

But a shift emerging in the financial world is making the pooling controversy less relevant. Rather than forgo sensible deals because of the accounting impact, companies have found a new platform to measure their operating results called "alternative accounting" or "cash multiple model."

This method of reporting financial results eliminates noncash amortization charges incurred when a business combination is recorded using purchase accounting. The emerging cash-basis accounting trend was spearheaded by investment banks to weed out noncash charges that reduce income and obscure operating results. Many feel this cash-basis accounting better reflects the fundamental economics of a M&A deal.

"People are looking at the real economics instead of GAAP accounting," Lloyd says. "By the time pooling is eliminated, people will be so used to cash-basis financials that any impact will be fairly minimal."

But this emerging cash-basis accounting trend could have drawbacks. "Different investment banks are looking at different numbers," states Mary Barth, a

Stanford Business School

professor who sits on the FASB board. "One of the things the FASB does is standardize the language of financial reporting. People are getting confused with all these different methods."

To those who contend the FASB proposal is irrelevant to accurate financial reporting, Barth offers a compelling counter-argument. "When there's a transaction between two parties, there's an established price." But pooling ignores this price, and continues using historical values, whereas purchase accounting updates the acquiring company to current values. So purchase accounting is a much more accurate, and hence relevant, way to account for an acquisition than pooling, Barth says.

"With pooling, we're basically ignoring a transaction," Barth says. "And that's not what accounting is about."

Eileen Buckley has no business relationship with the companies mentioned in this story. She has written about accounting issues for TheStreet.com and is also a contributor to Wired News.