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Document 1 of 3.

1997 Spring

SECTION: FASB AND THE EITF; Vol. 10, No. 3; Pg. 40

LENGTH: 6196 words

HEADLINE: Update on Accounting for Business Combinations

BYLINE: Diane E. Arutt, Richard L. Brezovec; Diane E. Arutt is a senior manager in Ernst & Young's national financial services industry group. Richard L. Brezovec is the national director of accounting and auditing for Ernst & Young's financial services industry practice.

BODY:
The top 10 banks controlled 50% of market capitalization in 1996; some estimate that will rise to 60% in three to five years. Many analysts predict that the merger trend will continue as banking companies deliver on promises made in earlier deals and financial institutions continue to seek cost efficiencies and opportunities to deploy excess capital.

Whether a business combination is accounted for as a purchase or as a pooling of interests can have a significant impact on the financial position and earnings reported by the combined entity. Recently, there has been a resurgence of interest in pooling -of-interests accounting. Seven of the top 10 mergers completed in the first half of 1996 were accounted for as a pooling of interests (Exhibit 1). Companies contemplating a business combination often view the benefits of pooling -of-interests accounting as an important element in deciding whether to pursue a proposed combination. For example, some companies view future expense charges related to amortization of goodwill resulting from the purchase method as an important factor in evaluating the economics of the transaction. And pooling -of-interests accounting treatment may even increase the value of the deal. Analysts are just beginning to warm up to purchase accounting by considering "cash earnings " (that is, before goodwill and other amortization). And many institutions prefer the flexibility to manage capital through share repurchases that purchase accounting affords. However, companies continue to structure transactions to conform with the pooling -of-interests method of accounting.

The requirements for pooling-of-interests accounting are complex, difficult to apply, and subject to subtle interpretation. The consequences of incorrectly assessing those requirements can be severe. Therefore, it is important to assess carefully the propriety of pooling-of-interests accounting for a particular business combination early in the merger process. At the American Institute of Certified Public Accountants (AICPA) National Conference on Current SEC Developments (December 10-11, 1996), the Securities and Exchange Commission (SEC) staff said that it receives more questions about poolings than about any other subject. This article will discuss some of the implementation questions and answers recently addressed by the SEC and highlight pending developments in accounting for business combinations.

Accounting for Business Combinations: Simple Theory, Complicated Implementation

The principal authoritative accounting pronouncement covering business combinations is Accounting Principles Board (APB) Opinion No. 16, "Accounting for Business Combinations. " APB Opinion No. 16 contains specific criteria to determine whether a particular business combination should be accounted for as a pooling of interests. If the criteria are met, pooling accounting is required; otherwise, the purchase method must be used.

In general, the purchase method accounts for a business combination as the acquisition of one company by another. Purchase accounting requires that the acquiring company allocate the purchase price and costs of the acquisition to all of the identified assets acquired and liabilities assumed based on their fair values. If the purchase price exceeds the fair value of the purchased company's identified net assets, the excess is recorded as goodwill and amortized to expense over a period not to exceed 25 years. Earnings or losses of the purchased company are included in the buyer's financial statements from the consummation date of the acquisition.

In contrast, the pooling-of- interests method accounts for the business combination as the uniting of the ownership interests of two companies by the exchange of voting equity securities in a manner that "shows that stock-holder groups neither withdraw nor invest assets but in effect exchange voting common stock in a ratio that determines their respective interests in the combined corporation. " In a pooling, the assets, liabilities, and retained earnings of each company are carried forward at their historical carrying amounts. Operating results of both companies are combined for all periods before the consummation date, and previously issued financial statements are restated as though the companies had always been combined.

While the theory underlying the pooling-of-interests method is a simple one, a business combination must meet 12 specific criteria to be accounted for as a pooling of interests. These criteria may be broadly classified as pertaining to ( 1) attributes of the combining companies, (2) manner in which the companies are combined, and (3) absence of planned transactions. All 12 criteria must be met if pooling accounting is to be used. If any one of the criteria is not met, the purchase method of accounting must be used. Exhibit 2 highlights these 12 criteria as set forth in APB Opinion No. 16 Paragraphs 46-48.

The specified criteria are complex. If pooling treatment is the objective, the merger partners must give early consideration to a host of issues in order to determine whether the constituent companies and the attendant plan of combination will qualify for pooling treatment under APB Opinion No. 16 and the various interpretations issued by the AICPA, Financial Accounting Standards Board (FASB), Emerging Issues Task Force (EITF), and SEC.

Treasury Stock Transactions Add Complexity to the Choice of Accounting Method

The effect of treasury stock acquisitions on whether certain business combinations may be accounted for as poolings of interests or as purchases has long been an accounting issue. The problem arises because, absent any restrictions on the use of treasury stock in a business combination, it would be possible for a corporation to acquire its voting common stock for cash or other valuable consideration, to exchange such stock for substantially all of the voting common stock of another company, and to account for the resulting business combination as a pooling of interests, whereas the transaction would be, in substance, a purchase of the acquired company's stock. Accordingly, many of the specific criteria required to be met for pooling-of-interests accounting revolve around stock transactions of each of the combining companies as well as the structure of the combination.

To account for a business combination as a pooling, APB Opinion No. 16 requires that each of the combining companies reacquire shares of voting common stock only for purposes other than business combinations and that none of the combining companies reacquire more than a normal number of shares between the initiation date and the consummation date. This introduces the concept that treasury shares are "tainted " unless they are acquired "only for purposes other than business combinations. " APB Opinion No. 16 also requires that, after the date the plan of combination is initiated, one of the combining companies (issuing corporation) issues voting common stock in exchange for at least 90% of the voting common stock of another combining company that is outstanding at the date the combination is consummated. This requirement limits the "tainted " stock to 10% or less of the voting common stock. However, as discussed further below, this can be misleading due to differing manners of calculating this limitation.

The SEC, in response to varying practice interpretations of APB Opinion No. 16, set forth its conclusions as to certain problems related to the effect of treasury stock transactions on accounting for business combinations in Accounting Series Releases (ASRs) 146, "Effect of Treasury Stock Transactions on Accounting for Business Combinations, " and 146A, "Statement of Policy and Interpretations in Regard to Accounting Series Release No. 146. " The AICPA also issued Accounting Interpretation No. 20 to clarify further the effect of treasury stock transactions on pooling accounting.

In May 1996, the SEC issued Staff Accounting Bulletin (SAB) 96, "Treasury Stock Acquisitions Following Consummation of a Business Combination Accounted for as a Pooling-of-Interests " (available on-line at the SEC website http//www.sec.gov/rules/ acctreps/sab96.txt). This represented a major change in practice by providing a much more restrictive interpretation as to when tainted treasury shares could be reacquired following the combination without violating the pooling-of-interests rules. SAB 96 states that, except in limited circumstances, an intention to reacquire stock that is part of the plan of combination (a "planned transaction ") precludes accounting for the combination as a pooling of interests. Limited circumstances include postconsummation reacquisitions of treasury shares that are considered "untainted " (for example, purchase of treasury stock pursuant to a systematic pattern) and postconsummation reacquisitions of tainted treasury shares up to the 10% limit permitted under APB Opinion No. 16. Furthermore, purchases of tainted treasury shares in the first six months after the business combination are presumed to be planned transactions prohibited by APB Opinion No. 16. The six-month period was based on the SEC staff's presumption that repurchases shortly after consummation of a business combination are evidence that the repurchases were part of the plan of combination.

SAB 96 raised many implementation issues that the pooling task force of the AICPA SEC Regulations Committee is attempting to clarify with the SEC staff. The pooling task force met with the SEC staff on these issues. In addition, the SEC staff shared its views about some of these issues at the December 1996 AICPA National Conference on Current SEC Developments. Some key points discussed included rescissions of prior authorizations; overcoming the presumption; repurchases after six months; postcombination treasury stock transactions -- gross vs. net; and treasury share repurchases under a systematic pattern of reacquisitions.

The SEC staff will apply SAB 96 literally to poolings consummated after its issue date (March 19, 1996). While there is no transition for prior poolings, the SEC staff will not actively look for violations of the positions expressed in SAB 96 that occurred before that date. The SEC staff expects that registrants would have made a good-faith effort (for example, by rescinding prior authorization to acquire treasury stock) as soon as possible after March 19 to comply prospectively. The SEC staff indicated that these situations are fact intensive and will continue to be reviewed on a case-by-case basis.

Rescissions of prior authorizations

While repurchases of the stock issued to a combining company's shareholders that are planned as a part of a business combination clearly violate APB Opinion No. 16, the SEC staff's more restrictive approach under SAB 96 now considers many routine repurchase transactions to be violations. Under SAB 96, a preexisting board of directors resolution authorizing management to purchase treasury shares in the future will be viewed by the SEC staff as a plan of reacquisition that could preclude pooling accounting.

To illustrate, assume Company A adopted a corporate resolution in January 1996 that allowed management to repurchase up to 10 million tainted shares over a two-year period. In December 1996, Company A initiates a business combination with Company B to be accounted for as a pooling and plans to issue a total of 40 million shares in exchange for Company B's stock. At consummation, tainted treasury shares total 3 million; Company A still has 5 million shares available (but not yet purchased) under its authorization. Under SAB 96, if the prior authorization is left in place pooling treatment is not available to Company A's combination with Company B, even though the authorization was in the ordinary course of business, it was unrelated to the pooling with Company B, and the number of tainted treasury shares at consummation was less than 10%. The pooling task force asked what has to be done in these circumstances.

The SEC staff indicated that prior repurchase authorizations must be formally rescinded in order for the shares remaining under the authorization not to be considered a part of the plan of combination subject to the 10% limitation. For companies that suspended repurchases under preexisting authorizations before consummation, board authorizations should be formally rescinded to avoid any implication that the suspension is simply temporary and that the share repurchases are planned to be resumed after the combination. To the extent retained or merely suspended, the prior authorization will be viewed by the SEC staff as a "planned transaction " in connection with the business combination. To the extent a company has room under the 10% limitation to repurchase additional tainted shares after the pooling, the SEC staff indicated that the company may modify a preexisting repurchase plan in lieu of rescission. However, the staff cautioned that such modification to a repurchase plan should quantify the tainted shares available for repurchase and should be clearly distinguished from any separate board authorization to purchase untainted shares pursuant to a systematic pattern. The SEC staff does not believe that a modification stating that the "registrant has modified its repurchase plan to conform with the pooling rules " is sufficient to inform interested parties of the significance of the change in plan.

Furthermore, the SEC staff believes that the disclosure of the rescission or modification must have equal prominence with the original authorization and implementation of the repurchase program. For example, if there was a public announcement of the repurchase program and an 8-K filed in connection with the original authorization, a similar public announcement should be made and an 8-K filed in connection with the rescission.

Overcoming the presumption

The AICPA's informal guidance for ASRs 146 and 146A included a presumption that significant reacquisitions of treasury shares shortly after a pooling were part of a planned transaction but stated that the presumption could be overcome by evidence to the contrary. SAB 96 now states that the SEC staff will presume that reacquisitions of tainted treasury stock within six months of consummation of a business combination are planned transactions that are part of the combination plan. While the SEC staff acknowledged that events outside the control of a company may cause it to repurchase its shares, the SEC staff believes there is an almost unrebuttable presumption that a company intended ( planned) to reacquire treasury stock at the date of consummation. The SEC staff indicated that it has addressed this issue in a fact pattern where market conditions had caused a precipitous decline in the registrant's stock price within six months after the combination, which led to a desire by the registrant to repurchase shares. The market decline was considered unrelated to the pooling (as it reflected market conditions in the registrant's industry that occurred subsequent to the combination), and the repurchase of shares was not contemplated at the date of combination. Even in that case, the SEC staff did not believe the registrant was able to overcome the presumption and commented that, thus far, it has been unable to envision any situation that would overcome the presumption.

Repurchases after six months

The SEC staff acknowledged that a "new decision " to authorize a share repurchase program for reasons unrelated to the business combination made at least six months after the date of consummation (based on the facts at that time) would not indicate a planned transaction that existed as of the consummation date.

For example, Company A enters into a business combination with Company B that in all respects meets the criteria for a pooling of interests. Seven months after consummation of the pooling, Company A's management presents to the board of directors a recommendation to adopt a stock repurchase program based on an analysis of current and projected financial conditions. Absent evidence that there was a plan to repurchase shares anytime during the prior six months, this action would not cause the SEC staff to question pooling-of-interests accounting for the earlier business combination.

Companies instituting repurchase programs more than six months after consummation of a pooling should clearly document their reasons for the repurchases based on current facts and circumstances that did not exist at the consummation date.

Postcombination treasury stock transactions -- gross vs. net

The SEC staff was asked to clarify the manner of computing the 10% limit -- specifically, whether that calculation is to be made on a gross or net basis after consummation of the transaction.

For example, a company with 8% tainted treasury stock at the date of consummation subsequently issues shares to satisfy option exercises and then repurchases shares to replenish its treasury. At no time does the company exceed 10% on a net basis. However, if the aggregate postconsummation purchases are added to the tainted treasury shares on the date of consummation, the sum could exceed the 10% limit.

The SEC staff has responded to the pooling task force that the calculation should be made on a gross basis. The SEC staff's interpretation states that pooling-of-interests accounting is precluded when the sum of (a) a company's tainted treasury stock purchases within six months after consummation (calculated on a gross basis), (b) the remaining balance under any unrescinded share repurchase authorizations (that would result in tainted shares), and (c) the tainted treasury shares on hand as of the consummation date exceed the 10% limit ( even though consistent with present practice companies are still able to cure tainted treasury shares by issuing shares before a pooling).

Treasury share repurchases under a systematic pattern of reacquisitions

ASR 146 states that treasury shares should be considered tainted unless all of the following criteria are met: (1) they are acquired to satisfy the exercise of options, issuance under stock compensation arrangements, conversion of convertible securities, recurring stock dividends, n1 or similar purposes; (2) they are acquired under a seasoned (established for at least two years n2 systematic pattern of reacquisitions; and (3) there is a reasonable expectation that the shares will be issued for the purpose for which they were acquired.

n1 A paid, declared, or planned stock dividend is considered recurring when at least one stock dividend similar in amount was paid in each of the preceding two years.

n2 Unless the plan was established concurrently with the adoption of a new stock option or stock compensation plan or the issuance of convertible securities.

The SEC staff acknowledged that under ASRs 146 and 146A, shares purchased for certain specific purposes are not tainted provided they are purchased under a systematic pattern of reacquisitions. However, the SEC staff emphasized that it expects the criteria of ASRs 146 and 146A to be rigorously applied and that the repurchase criteria must be sufficiently explicit so that the pattern of repurchases may be objectively compared to the plan.

Companies that have or are considering establishing a systematic repurchase plan should consider the documentation and implementation issues associated with the SEC staff's expectations. To avoid problems with potential pooling transactions, systematic repurchase plans must be clearly documented and must be based on reasonably objective criteria that may be objectively compared to the plan.

Requirements of a systematic pattern of reacquisition. A systematic pattern of reacquisition must be demonstrated by a formal plan (a reacquisition plan) that sets forth specified conditions for the acquisition of treasury shares. The criteria of the reacquisition plan must be sufficiently explicit so that the reacquisitions and the pattern of reacquisitions may be objectively compared to the plan. At the December 1996 SEC conference, the SEC staff specifically commented that in applying ASR 146, it has not objected to systematic patterns with formula-based criteria that leave little or no discretion in determining the number or timing of share repurchases, provided that the pattern of actual repurchases may be objectively compared to the plan. For example, a systematic pattern of treasury stock acquisitions can be based on a dollar amount of treasury stock purchases or a percentage of trading activity in a company's stock (that is, $ 10,000 of purchases per month or 1/4 of 1% of shares traded per month).

To illustrate its point regarding the need for an explicit plan, the SEC staff said that it had objected to a registrant's repurchase plan because the plan's criterion was that shares would be reacquired "whenever an unsolicited offer was received " but did not specify a number of shares. The SEC staff concluded that such a repurchase plan did not constitute a systematic pattern, because the criteria for the repurchase program did not specify the number of shares to be repurchased per block or per year. In that case, the only limit on repurchases was the total authorization, which exceeded the expected repurchases over the period of the authorization. Because the registrant was unable to compare actual repurchases objectively against the plan, the SEC staff concluded that the registrant did not have a systematic pattern. While the example provided by the staff was a rather obvious illustration of an unacceptable systematic plan, it was clear from the staff's comments that they expected a high degree of specificity and rigor in applying the requirements of ASRs 146 and 146A.

At the December 1996 SEC conference, the SEC staff said that a board of directors resolution or authorization to repurchase treasury shares need not contain all of the criteria necessary to establish a systematic pattern of repurchases. The board authorization may be supplemented by more explicit criteria developed by management that are sufficient to constitute a systematic repurchase program. However, the SEC staff would be concerned where any conflict exists between the terms of the board's repurchase authorization and the terms of management's purported systematic repurchase criteria.

Generally, acquisitions of treasury shares in excess of two years of anticipated issuances under stock option plans, warrants, or convertible securities would not meet the reasonable-expectation-of-reissuance test. Accordingly, treasury shares acquired for those purposes in excess of anticipated issuances of shares during the following two years would be tainted even though they were acquired under a systematic pattern of reacquisitions.

Subsequent revisions to the plan. A systematic pattern may be subsequently revised to increase or decrease the number of treasury shares being acquired if there is a reasonable basis for the revision. For example, the number of shares acquired pursuant to a reacquisition plan may change because of changes in the criteria used (cash availability, market price, etc.) or because of changes in the anticipated timing or number of shares needed for the purposes of reacquisition. For example, a systematic pattern of acquiring 3,000 to 5,000 shares a month could be revised at the end of six months to provide for the acquisition of 1,000 to 2,000 shares a month for the next six months because of a change in the number of shares expected to be issued for a stock option plan.

Changing the criteria of the repurchase program (for example, from a set dollar amount per month to a percentage of shares traded per month) would result in a new plan and a new two-year seasoning period before shares acquired under the plan would be considered untainted.

Purchases varying from plan and interruptions in activity. Significant differences between actual repurchases and repurchases calculated under the terms of the reacquisition plan would create a presumption that the criteria of the stated reacquisition plan -- unless those differences result from unanticipated interruptions caused by legal, contractual, or financial constraints on the company's ability to reacquire shares under its reacquisition plan.

For example, when the stated reacquisition plan requires repurchasing sufficient shares to offset the dilutive effect of common stock equivalents on earnings per share but actual repurchases are sufficient to meet only one year of expected future issuances and are not sufficient to offset fully the dilutive effect of common stock equivalents on earnings per share, the staff believes that the stated reacquisition plan is not, in fact, the reacquisition plan being followed. Under those circumstances, the actual reacquisition plan -- which requires repurchasing treasury shares sufficient to meet one year of expected future issuances -- should be used to determine whether treasury shares are tainted or untainted.

In addition to the legal, contractual, or financial constraints mentioned above, other circumstances exist that would permit the interruption of an otherwise systematic pattern without tainting treasury share acquisitions. Acquisitions of shares under an otherwise systematic pattern also would not be tainted if the share repurchases are interrupted due to the constraints imposed by SEC regulations on the aggregate number of treasury shares that may be purchased during a given period or during the period when a registration statement is in process. A registrant also may discontinue a systematic pattern because it concludes a reasonable expectation of reissuance no longer exists (for example, if the market price of the registrant's stock is less than 75% of the exercise or conversion price n3). The terms of debt agreements may also require the discontinuance of a systematic pattern (for example, maintenance of working capital or aggregate dollar amount permitted for dividends and treasury share acquisitions based on net income).

n3 As to stock option plans, warrants, or convertible securities, ASR 146 indicates that there would appear to be a reasonable expectation of reissuance of treasury shares acquired when the quoted market price of the common shares is not less than 75% of the exercise or conversion price.

In circumstances such as those illustrated above, where the interruption does not cause the treasury shares to be considered tainted, a resumption of treasury share acquisitions following the removal of the constraint would be considered a continuation of the previously established systematic pattern.

A special circumstance concerns a company with a systematic reacquisition plan that is interrupted because of legal, contractual, or financial constraints relating to an acquisition of a company. In that circumstance, the SEC staff would view as untainted those shares that are repurchased to replace shares that were issued during the period of interruption and that would have been reacquired pursuant to the plan had it not been interrupted.

Unseasoned systematic plan. Before the initiation of a business combination, a company may have adopted a formal plan to reacquire treasury shares that meets the conditions of ASRs 146 and 146A (that is, a systematic pattern of repurchases with a reasonable expectation of reissuance). However, unless the repurchase plan was adopted coincident with the adoption of a new stock option or compensation plan or the issuance of a new series of convertible securities, shares repurchased thereunder would be tainted until the second anniversary of the plan's adoption (that is, the plan is unseasoned). The concept behind seasoning is to be able to demonstrate that such ongoing treasury stock purchases were not in contemplation of a business combination. To comply with SAB 96, a company may be required to suspend repurchases under its unseasoned plan. Accordingly, the company may have suspended the reacquisitions because it had reached the 10% tainted share limitation or for other legal reasons. SAB 96 does not change the permissibility of share repurchases within six months of consummation of a pooling for a company that has a seasoned plan that meets the conditions of ASRs 146 and 146A; however, it does create an implementation question about unseasoned plans.

One approach would be that a company that suspended share acquisitions under an unseasoned systematic plan may wish to continue its unseasoned systematic pattern of treasury stock repurchases after consummating a business combination accounted for as a pooling provided that the 10% limitation is not exceeded and, upon reaching the 10% limit, the company would not continue repurchasing treasury stock until the two-year anniversary date of the start of the systematic plan.

The pooling task force suggested to the SEC staff that a practical approach would be to suspend the plan if necessary to avoid violation of the 10% limit and then allow the unseasoned plan to resume six months after the pooling (with the suspension period counting toward the two-year seasoned period). However, we understand that the SEC is taking a very conservative view on these situations. Until the SEC provides further clarification on this issue, caution should be exercised before effecting such transactions.

Miscellaneous issues. The following scenarios discuss a number of miscellaneous issues relating to systematic repurchase plans:

* If a reacquisition plan that encompasses the reacquisition of sufficient treasury shares to meet one year of expected future issuances is revised to encompass two years of expected future issuances, the staff believes that such a change would constitute a new reacquisition plan. Therefore, the additional treasury shares acquired under that new systematic pattern would be tainted during a two-year period beginning on the date that the new systematic pattern was adopted.

* Some plans have a history of assuming an appreciation in the price of the company's common stock during the next fiscal year for purposes of computing its authorized repurchases. The SEC staff would not object to a continuation of that methodology provided that the reasonable-expectation-of- reissuance test is met. However, if a plan historically did not assume an appreciation in the price of the company's common stock during the next fiscal year for purposes of computing its authorized repurchases, the SEC staff believes that adopting that assumption in the calculation of the current year's authorized repurchases would constitute a new reacquisition plan and, accordingly, a new two-year seasoning requirement.

* If a systematic pattern of acquisitions of treasury shares is started coincident with the adoption of a stock option plan and options under that plan are exercised for a number of shares that exceeds the number of treasury shares acquired, the excess applies to subsequent acquisitions that are part of the systematic pattern. For example, assume a stock option plan is adopted in May 1995 and a systematic pattern of treasury share acquisitions is begun. By May 1996, 40,000 treasury shares have been acquired in a systematic pattern, at which time options are exercised for 70,000 shares. There are no other treasury shares. The issuance of 70,000 shares for options exercised results in a 30,000 share excess to which 30,000 treasury shares subsequently acquired in a continuation of the systematic pattern are to be applied.

* Assume that options granted under a non-qualified stock option plan may not be exercised for five years. If a systematic reacquisition plan is adopted coincidentally with adoption of the option plan and the repurchase plan calls for purchases of treasury stock to begin after three years, the first shares reacquired would be untainted without an additional two-year waiting period.

* Assume a company starts a systematic pattern of treasury stock acquisitions under which shares are tainted for the first two years (that is, the reacquisition plan did not coincide with the adoption or significant change of a stock plan). Before the end of two years, the company has a business combination that must be accounted for as a purchase because of the existence of its tainted treasury shares. In this case, the two-year period necessary to establish a systematic pattern of reacquisitions does not start over again -- the starting date of the systematic pattern remains the original date the plan of reacquisition was adopted. The tainted treasury shares would be cured to the extent of shares issued in the purchase business combination.

* Subsequent to a business combination, the systematic pattern of treasury stock reacquisitions of the combined company could be determined by the issuing company's pattern, the acquired company's pattern, or some combination of the two patterns depending on the facts in each case. If the business combination is accounted for as a purchase, the acquiring company's pattern carries forward. If new purposes for which untainted treasury shares might be purchased arise from a purchase combination, a plan for systematically acquiring treasury shares could be established coincidentally and a two-year waiting period would not be required. If the combination is accounted for as a pooling of interests, the existing reacquisition plans of either or both companies can be carried forward as they relate to securities that survive the combination.

New FASB Project to Reconsider Accounting for Business Combinations

In several recent speeches, Mike Sutton, chief accountant of the SEC, discussed the application of the pooling-of-interests provisions of APB Opinion No. 16. He noted that an inordinate amount of time is spent in dealing with registrant accounting issues related to business combinations and, in particular, the pooling criteria of APB Opinion No. 16. He also pointed out that, since the publication of APB Opinion No. 16 in 1970, continuing consideration of business combination issues has required 39 formal interpretations published by the AICPA, more than 50 EITF issues, at least 8 SABs, and various other technical interpretations. Mr. Sutton believes that "the time is ripe for reconsidering APB Opinion No. 16 and the circumstances, if any, in which pooling-of-interests accounting should be permitted. " He encouraged the standard setters and others "to consider the opportunity it presents for harmonizing U.S. accounting practices with practices prescribed by the International Accounting Standards Committee (IASC) in its International Accounting Standard No. 22 (IAS 22), 'Accounting for Business Combinations.' "

At a recent FASB meeting, based on the SEC staff's views as well as a recommendation of the Financial Accounting Standards Advisory Council (FASAC), the FASB unanimously voted to add two business combination projects to its agenda. One project would deal with the pooling-of-interests method and would reassess the appropriateness of the method. The second project would deal with application issues related to purchase accounting. In reaching this decision, the FASB noted that a business combinations project poses an opportunity for international harmonization, since Canada, the United Kingdom, and the IASC already have a similar approach for distinguishing business combinations that should be accounted for as a purchase from those that should be accounted for as a pooling of interests.

Most business combinations outside the United States are accounted for using the purchase method of accounting. IAS 22 requires that an acquisition be accounted for using the purchase method and that a "uniting of interests " be accounted for using the pooling-of-interests method. IAS 22 defines a uniting of interests as a business combination in which the shareholders of the combining in which the shareholders of the combining enterprises combine control over all, or substantially all, of their net assets and operations to achieve a continuing mutual sharing in the risks and benefits of the combined entity in a manner that does not permit either party to be identified as the acquirer. Although some countries allow an approach similar to the pooling-of-interests method as an alternative to purchase accounting, that method is permitted only when specified criteria (much narrower than the criteria in the United States) are met.

While some promote the elimination of pooling-of-interests accounting as a move toward greater international harmonization, the advisability of the FASB attempting to bring international consistency to an area as complex as business combinations is questionable, particularly when other efforts to harmonize far less complex areas have been difficult to achieve (for example, segment reporting).

ENDNOTES:
n1 A paid, declared, or planned stock dividend is considered recurring when at least one stock dividend similar in amount was paid in each of the preceding two years.
n2 Unless the plan was established concurrently with the adoption of a new stock option or stock compensation plan or the issuance of convertible securities.
n3 As to stock option plans, warrants, or convertible securities, ASR 146 indicates that there would appear to be a reasonable expectation of reissuance of treasury shares acquired when the quoted market price of the common shares is not less than 75% of the exercise or conversion price.

LANGUAGE: ENGLISH

LOAD-DATE: May 15, 1997

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