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FASB's Politically Motivated (?) Move.

As it fine-tuned its statement on Business Combinations A and Intangible Assets, did the Financial Accounting Standards Board buckle under political pressure from the likes of U.S. Senate Banking Committee chairman, Sen. Phil Gramm (R-Texas)? Some suggest that was the motivation behind FASB's January announcement that it had reconsidered its original approach to goodwill for business combinations.


The purchase method (popular worldwide) and pooling of interests method are the two methods used for recording business combinations. When a business combination is recorded using the purchase method, fair market values are used to record the acquisition. Any excess of the acquisition cost over the fair market value of the net assets of the acquired subsidiary is charged to goodwill. When the pooling of interests method is used, the acquired entity's net assets are recorded at their book values. No goodwill is recorded.

A business combination, when strictly following the intent of GAAP, can be recorded using only one of the two methods. The two methods are not options. Only one is acceptable in a given situation, depending on the nature and conditions of the business combination.

Pooling of interests is popular in the U.S. primarily because it results in higher reported earnings, subsequent to the business combination, when compared to the purchase method. There is no goodwill recorded at the time of the business combination. Consequently, there is no subsequent amortization of goodwill, resulting from the business combination, to be charged against future revenues.


In September 1999, FASB issued an exposure draft: Business Combinations and Intangible Assets. It proposed that all U.S. companies account for business combinations according to the purchase method only. FASB gave several reasons for proposing the elimination of the pooling of interests method, including:

* The purchase method is consistent with how the accounting model records acquisition of assets and incurrance of liabilities;

* The underlying rationale for using the pooling of interests method is "illogical" because the combination does not result in continuation of the same interests;

* Unlike other exchange transactions, the pooling of interests method does not record fair values of the items exchanged;

* Information produced from pooling is less useful for making decisions because it is less relevant and less reliable. It is less relevant because of its lack of predictive value compared to the more useful purchase method. The pooling of interests method is less reliable, especially in terms of representational faithfulness, because practically all business combinations are acquisitions (and not mergers);

* Comparability is enhanced nationally and internationally when all business combinations are accounted for using one method.

In its proposal, FASB said that goodwill recorded using the purchase method should be amortized, using the straight line method, over a maximum period of 20 years.


Predictably, there was strong opposition to the exposure draft, specifically to the goodwill amortization.

In January, FASB announced its tentative decision to maintain its original plan and eliminate pooling. All business combinations would be accounted for under the purchase method only. However, goodwill would not be amortized against earnings. It would be reviewed for impairment, and written down only in those periods in which its recorded value exceeds its fair value.

While concern ran high through the business world with FASB's initial proposal, the likely impact of the imminent new standard on the acquisitions strategy for high-tech companies is less. According to Janice McLelland, Cisco's director of finance, "It won't slow the pace of our acquisitions." But she adds that the new standard will have a greater impact on brick and mortar companies. However, McLelland says that for all companies, "[applying the impairment test to determine the fair value of goodwill] will be a huge challenge."


FASB currently is reviewing comments to its revised exposure draft and expects to issue its final statement by the end of June. Stay tuned.

M. Zafar Iqbal, CPA, Ph.D, is a professor of accounting at Cal Poly State University, San Luis Obispo and a member of Ca/CPA's stale Global Opportunities Committee. He can be reached at or (805) 756-2977.
COPYRIGHT 2001 California Society of Certified Public Accountants
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Article Details
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Title Annotation:Financial Accounting Standards Board
Publication:California CPA
Article Type:Brief Article
Geographic Code:1USA
Date:May 1, 2001

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