FREE online courses on Mergers & Acquisitions - Chapter 2 - Accounting Principles

 

One last item that we should discuss is the application of accounting principles to mergers and acquisitions. Currently, there are two methods that are used to account for mergers and acquisitions (M & A):

 

Purchase

 

The M & A is viewed prospectively (restate everything and look forward) by treating the transaction as a purchase. Assets of the Target Company are restated to fair market value and the difference between the price paid and the fair market values are posted to the Balance Sheet as goodwill.

 

Pooling of Interest

 

The M & A is viewed historically (refer back to existing values) by combining the book values of both companies. There is no recognition of goodwill. It should be noted that Pooling of Interest applies to M & A's that involve stock only.

 

In the good old days when physical assets were important; the Purchase Method was the leading method for M & A accounting. However, as the importance of intellectual capital and other intangibles has grown, the Pooling of Interest Method is now the dominant method for M & A accounting. However, therein lies the problem. Because intangibles have become so important to businesses, the failure to recognize these assets from an M & A can seriously distort the financial statements. As a result, the Financial Accounting Standards Board has proposed the elimination of the Pooling of Interest Method. If Pooling is phased out, then it will become much more important to properly arrive at fair market values for the target's assets.