Pooling-of-Interests: Definition, How it Worked, Replacement

What Is Pooling-of-Interests?

Pooling-of-interests was a method of accounting that governed how the balance sheets of two companies were added together during an acquisition or merger. The Financial Accounting Standards Board (FASB) issued Statement No. 141 in 2001, ending the usage of the pooling-of-interests method.

The FASB then designated only one method—purchase accounting—to account for business combinations. In 2007, FASB further evolved its stance, issuing a revision to Statement No. 141 that the purchase method was to be superseded by yet another improved methodology—the purchase acquisition method.

Key Takeaways

  • Pooling-of-interests was an accounting method that governed how the balance sheets of two companies that were merged would be combined.
  • The pooling-of-interests method was replaced by the purchase accounting method, which itself was replaced by the current method, the purchase acquisition method.
  • The pooling-of-interests method combined the assets and liabilities of both companies at book value.
  • Intangible assets, such as goodwill, were not included in the pooling-of-interests method and were therefore preferred over the purchase accounting method, as it did not result in having to pay amortized costs, negatively impacting earnings.
  • The adjustment by FASB to incorporate impairment tests before including amortized expenses reduced the impact of the purchase accounting method.

Understanding Pooling-of-Interests

The pooling-of-interests method allowed assets and liabilities to be transferred from the acquired company to the acquirer at book values. Intangible assets, such as goodwill, were not included in the calculation. The assets and liabilities were simply summed together for a net number in each category when combining both balance sheets.

The purchase accounting method recorded assets and liabilities at fair value as opposed to book value, and any excess paid above the fair value price was recorded as goodwill, which needed to be amortized and expensed over a certain time period, which was not the case in the pooling-of-interests method.

The purchase acquisition method is the same as the purchase accounting method except that goodwill is subject to annual impairment tests instead of amortization, which was done to placate businesses that had to start paying expenses due to the amortization of goodwill.

The Elimination of Pooling-of-Interests

One reason FASB ended this method in favor of the purchase accounting method in 2001 is that the purchase accounting method gave a truer representation of the exchange in value in a business combination because assets and liabilities were assessed at fair market values.

Another rationale was to improve the comparability of reported financial information of companies that had undergone combination transactions. Two methods, producing different results, at times vastly different, led to challenges in comparing the financial performance of a company that had used the pooling method with a peer that had employed the purchase accounting method in a business combination.

The primary reason, and the one that caused the most opposition to changing the methods, was including goodwill in the transaction. The FASB believed that the creation of a goodwill account provided a better understanding of tangible assets versus intangible assets and how they each contributed to a company's profitability and cash flows.

Companies, however, would now have to amortize and expense goodwill over a period of time. As the pooling-of-interests method did not include goodwill, the price above the fair value price, would not have to be paid off or expensed. This changed under the purchase accounting method, which therefore had a negative impact on earnings. This issue was resolved by the adjustment of using a non-amortized approach by incorporating an impairment test, which would determine if the goodwill was higher than its fair value, and only then would it have to be amortized and expensed.