New rule ends pooling method for mergers, requires goodwill evaluation
To pool or not to pool? That used to be the question officials would ask when acquiring another company.
But with a new ruling by the Financial Accounting Standards Board (FASB), acquiring companies may no longer use pooling, which simply added two companies’ assets together. Under the purchase method of consolidation, the balance sheet of the acquired company is marked at fair value and then compared to the purchase price. Any excess of purchase price over net assets created goodwill that was amortized over 40 years.
The new FASB statement eliminates the use of the pooling method entirely after July 1 because FASB wants uniformity in the global economy and everyone else uses the purchase method for acquisitions, notes Bill Hogan of Wipfli CPAs & Consultants in Wauwatosa.
The other reason for the change is that the goodwill and its related amortization (write-off) were misleading to financial statement users.
“FASB felt that the pooling method disguised the value of the merger, or didn’t let the investor know what the value of the merger was over time,” Hogan said.
Pooling provided stronger-looking income statements by having no write-offs of goodwill, as in the purchase method. However, the new FASB statement requires companies to evaluate the goodwill on their books and determine if it is “impaired” on an annual basis. Impairment in this case means the goodwill’s book (or carrying) value exceeds the fair market value and thus is written down.
The FASB statement covers all companies with goodwill on their books, no matter when it originated.
Critics of the FASB say that annual determination — by company management — could further cloud a financial statement user’s judgment as to the true value of the company because management could manipulate the size of the annual write-off. But supporters say management was hiding behind the balance sheet when they (sometimes frivolously) overpaid to buy another company and goodwill impairment may make shareholders more aware of that.
“In reality, I think the analysts will keep doing what they do now,” Hogan says. “I think when an analyst looks at a financial statement, they discount goodwill. They may look at the cashflow earnings of a business, which will continue to happen.” But, he warns, casual observers may be fooled by management’s ability to change earnings by virtue of the impaired goodwill write-offs.
As with all new pronouncements or guidelines, the real test will be when companies and their outside accountants start adjusting goodwill for impairment. If the new rule proves to confound practitioners and academics alike, FASB is likely to issue another ruling, according to Hogan.
One thing’s for sure, he said. “Pooling is dead.”
July 6, 2001 Small Business Times, Milwaukee
