Whither Poolings?

As Financial Executive went to press, the FASB prepared to issue its exposure draft on business combinations and intangible assets. Here's a glimpse at the latest thinking behind the FASB's important project - what issues are left to be resolved and how FEI members can influence the discussion.

In mid-August, Financial Executive invited FASB Chairman Ed Jenkins and FASB Project Manager Kim Petrone to talk with John Wulff, vice president, CFO and controller of Union Carbide and immediate past chair of FEI's Committee on Corporate Reporting (CCR), and Peter Bible, chief accounting officer at General Motors and head of CCR's subcommittee on the business combinations project, about the FASB's decision to reconsider its opinions on business combinations and intangible assets. FEI President and CEO Phil Livingston moderated the discussion.

An edited transcript of that conversation follows.

Phil Livingston, FEI: What's the status of the business combinations project? What can we expect next and when?

Ed Jenkins, FASB: The exposure draft should be issued in early September. There will be a 90-day comment period. After receiving the comments, we plan to hold public hearings (probably in the first two weeks of February 2000) and begin re-deliberations. Each issue that requires a decision will be re-deliberated in public, in light of what we learn. We also expect to hold meetings, maybe educational sessions conducted by constituents to discuss the impact of our new standards. So we have a lot of due process ahead. It takes so long because we re-deliberate each issue as we go.

John Wulff, Union Carbide: Assuming you meet the schedule, when would the standard be effective? And broadly speaking, what would be the transition rules?

Kim Petrone, FASB: The standard will be effective for transactions initiated after the final statement is issued, probably at the end of 2000. All prior transactions would be grandfathered.

Jenkins: And we'd use the same definition of initiation we currently have in Opinion 16. So if you initiate but haven't closed a transaction at the time the new standard is issued, you'd still be under the old rule.

Livingston: I did some research and was amazed to learn the history of business combination accounting in the United States. We're coming up on the 30-year anniversary of APB 16. Ed, can you comment on where we've been with this?

Jenkins: Accounting for business combinations goes back to the '30s, when public utility companies were merging rapidly after the Depression. The concern was that the basis for setting rates was historical cost of assets. When an acquisition was made, the cost - in addition to original cost (which is one way of expressing the difference between the fair value of the assets and including goodwill and the historical cost, or book value) - wasn't permitted to be recovered in utility rates. The concept of pooling of interests developed there.

Then, of course, something similar to pooling-of-interest accounting has always been used in related party transactions or intercorporate mergers and such. That, in fact, will continue under the exposure draft.

But Opinion 16 arose because the pooling criteria were perceived as being abused. I can remember, for example, the problem of acquisitions completed after the end of the year but before the financial statements were issued being reflected in the previous year; there were a lot of window-dressing transactions. That was one abuse. Another abuse was grounded in issuing stock at the same time as buying back treasury stock, so at the end of the day it was as if you'd issued cash.

Those kinds of concerns led to Opinion 16, which tried to establish some conditions for pooling transactions. As you know, those conditions are pretty arcane and mechanical. Some of them don't even reflect the substance of the current approach to pooling, because they're designed to control a size test, which ultimately was dropped from the standard.

So we've been living with Opinion 16 for nearly 30 years, and poolings have increased. Certainly the current high market multiples have led to management's desire for more poolings than purchases. Indeed, we see significant evidence, in merger contracts and otherwise, that some companies won't go through with an acquisition unless pooling accounting can be achieved.

At the same time, the SEC has been trying to restrict poolings; it has an adverse view of the method. And [it adds] arcane interpretations to the already arcane conditions for achieving a pooling, so it's difficult today for companies to know whether they actually can achieve pooling-of-interest accounting until they've gone down to the chief accountant's office. And usually that's late in the game.

We put this item on our agenda because of some of these concerns, because of what was going on internationally and because we've always felt at the FASB that, conceptually, an acquisition is an acquisition is an acquisition - and what's basically the same transaction (the acquisition of assets or a group of net assets by a company) shouldn't attract such drastically different accounting.

Livingston: Some people think pooling doesn't hold management accountable for the acquisitions and decisions it makes. Is this a major reason for the proposed rule change?

Jenkins: Suppose you acquire a company with a book value of $30, issue stock that has a value of $100 and account for it as a pooling. So the assets are recorded at $30. Two years later, assume you sell that same company for $90. You'd recognize a gain on the transaction of $60 - the difference between $30 and $90 - when actually, in terms of the value of the...