The Pooling of Interest Method in Business Mergers

Companies historically have had two methods for accounting for business combinations: the purchase price method and the pooling of interests method. However, the Financial Accounting Standards Board, or FASB, and the Securities and Exchange Commission faced substantial pressure to eliminate the use of the pooling of interests method, which it did in early 2001. Investors and analysts were dissatisfied with the lack of information about the acquiring company and the purchase price using the pooling method. The SEC also complained that approximately 50 percent of its staff’s time was allocated to reviewing proposed pooling combinations.

The pooling of interests method of accounting for mergers and acquisitions involves consolidating the balance sheets of the two companies into one balance sheet based on book values. This is followed by the restatement of historical financial statements. This method excludes intangible assets from the consolidated balance sheet unless they were already recognized on the balance sheet of one of the legacy companies. As such, no goodwill is reported in connection with the acquisition or merger. Expenses associated with the business combinations were written down as part of the company’s comprehensive income.

Certain sectors preferred using the pooling of interests method of accounting for business combinations before its discontinuation. The use of the method peaked during 1998, when it comprised 52 percent of all deal volume. In dollar terms, this equaled $852 billion. Large technology companies used the pooling of interests method, because they were able to avoid recording the related acquisition costs. It also made earnings look stronger, because no write-downs for goodwill were required under the method. This had the additional benefit of increasing returns on assets and equity.

The pooling of interests method was discontinued in the U.S. in 2001 as part of the accounting industry’s general shift to fair value accounting. Purchase price accounting had existed as an alternative to the pooling of interests method, but the new Standard 141 on business combinations superseded prior FASB rulings on business combinations. This was later superseded by Accounting Standards Codification Topic 805, FASB’s most current position on business combinations, which offers even more detailed guidance on the use of fair value in financial reporting requirements.

The purchase price method involves producing a balance sheet consolidated on a fair value basis. When a company purchases a target company, ASC 805 provides comprehensive guidelines on how to calculate the various components of goodwill, including intangible assets such as customer lists, trade names and beneficial leases. Ernst & Young released a report in 2009 publishing the purchase price allocation practices of 54 telecommunications transactions. The results showed that intangible assets comprised an average of 30 percent of the acquired companies’ enterprise values, with goodwill accounting for an average 60 percent of enterprise values. Intangible assets included a wide variety of assets, such as trademarks and trade names, technology, noncompete agreements, contracts, customer relationships and licenses.