The following article is adapted from reprinted from the M&A Tax Report, Vol. 7, No. 11, June 1999, Panel Publishers, New York, NY.
POOLING OF INTERESTS ACCOUNTING TO BE OUSTED
By Robert W. Wood, San Francisco
In the past, this newsletter has devoted no small attention to the pooling of interest accounting rules. True, it is not strictly a tax topic, as pooling of interest deals are taxable transactions and creatures of the accounting rules, not the Internal Revenue Code. Nonetheless, the tax practitioner (lawyer or accountant), investment banker, broker and business owner or executive ought to have at least a passing understanding of how pooling transactions work. There seems to be a paucity of knowledge about even the rudiments of pooling of interest transactions. Everyone seems to know the name, but relatively few people seem to know the game.
For prior coverage of pooling treatment basics, lest we repeat them all here, see Willens, Exchangeable Notes Preserve Pooling," Vol. 7, No. 4, The M&A Tax Report, November 1998, p. 5; and Willens, "FASB Discloses Direction of ‘Pooling' Project," Vol. 6, No. 4, M&A Tax Report, November 1997, p. 7.
On the Way Out
It has been no secret that pooling of interest accounting has created substantial controversy. Suggestions have been made for several years about change, perhaps radical change that would cut back on the distinct advantages of a pooling. Now, however, the Financial Accounting Standards Board (FASB) unanimously voted to eliminate the pooling of interests method of accounting for business combinations. See MacDonald, "FASB To Decide if Accounting Tool Will Be Eliminated," Wall Street Journal, April 21, 1999, p. A4. See also Tax Notes, April 26, 1999, p. 540.
The decision, by a whopping 8-0 vote, tentatively decided to use the purchase method as the preferable accounting method for business combinations. This ends a more than 30-year run of the pooling method. Interestingly, one of the justifications used for the elimination of the pooling transaction was that too many choices confuses people. (Is this Big Brother or what?) The purchase method, said FASB Chairman Ed Jenkins, will give investors a better idea of the true initial cost of a transaction and the performance of the investment over time than pooling transactions ever did.
Effective Date Uncertain
The effective date for this bold move has not yet been determined, although a final statement on the matter is expected to be issued sometime late in the Year 2000. That gives businesses in this current frenzied acquisition market plenty of time to pool to their heart's content. Indeed, FASB member Gaylen Larson has expressed concern about their being a flurry of business activity before the effective date of the change.
It is unclear, incidentally, whether other international accounting standard proctors (besides the FASB) will take the same kind of action, although some say that they will. The Canadian accounting standard-setters are meeting as this article is written, and are to address the issue. It remains to be seen what will happen with respect to other countries. As far as the flurry of activity is concerned, the FASB even confirmed that pooling under the current rules will continue to be available for transactions that are initiated on or before the date on which a final statement is issued. Again, that is not likely to be until late in the Year 2000. The FASB acknowledged that the effective date may even end up being for transactions initiated on or after January 1, 2001.
The definition of the word "initiated" could, of course, be twisted and turned by creative lawyers. The suggestion, though, is that a transaction for this purpose will be considered to have been initiated on the date on which the major terms of the plan (including the exchange ratio) are publicly announced. That would seem to suggest that, even if not immediately, transactions will be hurried up to the point where terms can be set as this now seemingly distant prospective effective date begins to loom more into our immediate future.
Just Say "No" to Fresh Start
No, "fresh start" is not a new healthful fast food chain. Instead, it is a purchase accounting model with respect to which the assets of both constituent corporations are revalued in connection with a transaction. The FASB rejected a change to a purchase accounting model. Instead, as is normally the case, only the assets of the target corporation are revalued. The FASB has apparently wrestled mightily with the question of the identity of the acquiring company. In some purchase accounting transactions that are handled by an exchange of shares, it may not be clear who is buying whom.
Tentatively, the FASB agreed that the "acquirer" should be considered to be the entity whose shareholders emerge from the transaction with the majority of the voting stock. This voting stock determination is to be made on a fully diluted basis (except where the acquired corporation contributes the majority of the members of the Board of Directors and senior management). In the cases referred to in the last parenthetical, where shareholders of one company emerge with a majority of voting stock but the other corporation supplies a majority of the Board and senior management, it is not yet clear who will be considered the acquirer. It isn't even clear exactly what criteria the FASB will use to determine who the acquirer might be. Obviously, there is considerable spade work to be done on this accounting standard change.
Further Developments
With the apparent death sentence for pooling transactions slated for the future, it could be argued that it is less relevant for professionals and businesses to understand pooling deals. But my prediction is that pooling is not going to go in a quick plunge. Instead, I think we can expect pooling transactions to accelerate between now and whenever the FASB sets the new effective date of poolings execution. And even then, as with most last minute shoppers, I think we'll see a rush to do transactions (and at least have the transaction "initiated") before the effective date kicks in.
'Pooling of Interests' Accounting to be Ousted, Vol. 7, No. 11, The M&A Tax Report (June 1999), p. 1.