Death to "pooling of interests"?

Acquisitions of high-tech companies will likely be a lot more costly toward the end of next year now that an accounting treatment the industry favors is expected to fade away.

Dawn Kawamoto Former Staff writer, CNET News
Dawn Kawamoto covered enterprise security and financial news relating to technology for CNET News.
Dawn Kawamoto
4 min read
Acquisitions of high-tech companies, especially Internet ventures, will likely be a lot more costly toward the end of next year now that an accounting treatment the industry favors is expected to fade away.

The Financial Accounting Standards Board, a quasi-government organization that sets accounting guidelines, today voted to eliminate the "pooling of interest" accounting method.

Public comment will be taken on the issue, and the FASB board can change its stance, but the board rarely reverses earlier decisions, said Kim Petrone, FASB project manager.

Concern has swept through the high-tech industry that fewer acquisition deals will be done once the new guidelines take effect--slowing the industry's growth and throwing cold water on the desire by Internet companies to use their lofty stock valuations to snap up companies. Internet companies such as portal giant Yahoo already are showing some trepidation in doing deals unless they qualify for a pooling of interest accounting method.

But FASB, which says it is seeking to create a level playing field for mergers and acquisitions with U.S. and international companies, had previously voiced its interest in doing away with the pooling of interest accounting treatment altogether, much to the dismay of many corporations, especially high-tech companies.

Pooling of interest basically allows companies to combine their operations in a merger and avoid taking a hit to their earnings over a period of time by avoiding the use of "goodwill."

Goodwill represents the difference in value between the seller's assets when they were originally purchased and the current market value for those same assets.

Without pooling, companies can only use the "purchase accounting" method, in which the buyer will have to include goodwill in their books. Buyers have to write off this premium--the difference between the seller's book value and market value for their assets--over a period of time, sometimes spanning as long as 40 years. And these goodwill write-offs result in a hit to earnings.

"Internet companies especially have the greatest disparity between the market value for their assets and the book value. That's why they don't want to see the accounting changes," said Paul Zarowin, associate professor at New York University's Stern School of Business.

Tech companies may find one silver lining, however. FASB is not expected to eliminate the current practice of allowing companies to use either cash or their lofty stock valuations as currency to buy companies under the purchase accounting method.

Nonetheless, tech companies are opposing the change. FASB received 140 comment letters from firms reacting to the possible accounting changes, more than a third of which came from the high-tech industry, Petrone said.

"FASB wants to eliminate pooling altogether, and this will hurt technology," said Arvind Sodhani, vice president and treasurer of chip giant Intel. "In old-line industries, companies that bought each other tended to have similar book values and [price-to-earnings] ratios. But for high-tech, where the PE multiples and valuations are higher, the amortization of goodwill is painful."

For its part, Yahoo noted in a regulatory filing that "the availability of [the pooling of interest] accounting treatment is a condition to the merger" with community site GeoCities. Yahoo in January announced its stock-swap deal with GeoCities, valued at $3.56 billion and another $1 billion in options. This deal, however, is not expected to be affected by FASB's decision, as it's not expected to take effect until the end of next year.

Amy Callahan, vice president of the Western region for the Information Technology Training Association, said her trade group is concerned that these changes to the use of pooling will stunt the growth of the U.S. tech industry.

"High tech contributed 8.6 percent to the [gross domestic product] last year, and why would we want to harmonize our methods to the international accounting methods?" she said. "It makes no sense. We have been the leader, and it's because we've been allowed to do pooling of interest."

But Petrone maintained that a good deal shouldn't be contingent upon one accounting practice.

"If a deal makes good economic sense, then the accounting shouldn't matter," she said.

She also noted that by creating one system for accounting for mergers and acquisitions, investors may find it easier to compare companies in which they might want to invest.

Both FASB and theSecurities and Exchange Commission have been deluged by questions from companies wanting to know if they qualify for a pooling of interest treatment, Petrone said.

"This indicates the standard isn't working if you get a lot of questions," she said.

She also noted that by creating one system for accounting for mergers and acquisitions, investors may find it easier to compare companies in which they are considering investing.

Meanwhile, the SEC has taken a tougher stance on which companies are able to use the pooling method over the past year or two, observers say. SEC officials declined to comment on the possible changes in accounting practices.

"Back in the 1960s, about half the deals used pooling of interest. Today it's down to around 10 percent," said James Ratliff, an associate professor with New York University's Stern School of Business. "The use of pooling has dropped quite a bit because it's more difficult to do since the SEC has gotten tougher in allowing companies to use it."

The pooling of interest practice is expected to be terminated by the end of next year, Petrone said. Companies that have already announced their merger plans but have not yet closed the deal by the time the new guidelines take effect will be allowed to move forward, she added.