Frank R. Rayburn and
Ollie S. Powers
THE UNIVERSITY OF ALABAMA AT BIRMINGHAM

A HISTORY OF POOLING OF INTERESTS ACCOUNTING FOR BUSINESS COMBINATIONS IN THE UNITED STATES

Abstract: This paper traces the development of pooling of interests accounting for business combinations from 1945 to 1991. The history of the pooling concept is reviewed chronologically with particular emphasis on the events of 1969-1970 that were related to the most recent pronouncement on the subject, Accounting Principles Board (APB) Opinion No. 16. Early in its life (1974), the Financial Accounting Stan-dards Board (FASB) placed a project on its agenda to reconsider pooling of interests accounting. That project was removed from the FASB’s agenda in 1981. APB Opinion No. 16 has gone essentially unchanged as it relates to the accounting for a business combination as a pooling of interests. Resolution of implementation issues has been left largely to the Securities and Exchange Commission and the accounting profession. The FASB has a project on its agenda on Consolidations and Related Matters that may impact pooling of interests accounting. There also is some pressure for the FASB to revisit accounting for business combinations.

Current authoritative literature, Accounting Principles Board (APB) Opinion No. 16, “concludes that the purchase method and the pooling of interests method are both acceptable in accounting for business combinations, although not as alternatives in accounting for the same business combination” [par. 8]. If a business combination meets all twelve specified conditions [see APB Opinion No. 16, Pars. 46-48], it must be accounted for as a pooling of interests. All other business combinations must be accounted for as purchases.

The pooling of interests method of accounting for business combinations has generated debate since its inception. In a pooling of interests, a new basis of accounting is not permitted. Rather, the assets and liabilities of the combining companies are carried forward at their recorded amounts and retained earnings of the companies are combined [APB Opinion No. 16, Par. 12].

Wyatt [1963, p. 19] suggests a starting point for the theoretical foundations of the concept:

While the term “pooling of interests” probably did not evolve until later, the two principal accounting characteristics of the “pooling” accounting treatment were recognized as early as the 1920s. These two characteristics involve (1) the carrying forward of the retained earnings (earned surplus) of the constituents as retained earnings of the resultant entity, and (2) the carrying forward of the book values of the assets of the constituents as the book value of the assets of the resultant entity.

A survey of the literature suggests that the major issue in these early years was earned surplus. The accounting concept that a corporation may not begin business with a surplus was well established [see Dickinson, 1914, p. 185].

Wildman and Powell [1928, p. 224] challenged not only this concept regarding earned surplus, but also the revaluation of assets in a business combination. Their comments sound very much like a modern argument in support of pooling of interests.

A highly controversial point related to consolidations concerns the idea that corporate units lose their surplus when legal consolidation is effected by means of a newly organized successor corporation. Those who contend for this view argue that it is impossible for a new corporation to acquire surplus without having operated a sufficient length of time to have derived surplus from earnings. In other words, a corporation may not begin business with a surplus. Further, they hold that the surplus of a constituent company becomes capitalized when that company becomes consolidated.

The argument just advanced appears to be founded on a view that looks to the form rather than to the substance of the matter. Recognition should be given, it seems, to the fact that a new corporation is organized merely as a legal convenience. The value of assets prior to consolidation is not changed necessarily by the legal formality of transferring them to a new owner. The liabilities of constituents are neither increased nor decreased by the process of combination. Under such circumstances, it would appear that any excess of assets over liabilities remains the same both before and after consolidation. Finally, if the excess represented surplus available for dividends before consolidation, it must necessarily represent the same thing after consolidation.

In the 1932 edition of Accountants’ Handbook, the subject of the effect of reorganizations on surplus was discussed:

.. . Where there has been no change of beneficial interest, as where stock in the holding company is exchanged for a controlling interest in the stock of the subsidiary or where two companies are merged and a new unit has grown out of the two previously existing identities, there is no absorption of surplus unless an intention exists to do so, in which event the equivalent of a stock dividend has been paid [Paton, ed., 1932, p. 950].

Further evidence that the concept of carrying forward the earned surplus of merging companies had been accepted by the early 1930s is provided by Montgomery [1934, pp. 416-17]:

When two or more corporations merge or consolidate, the owners may assume that the old entities are continuing in a slightly different form and that the combined earned surplus of all will form the aggregate earned surplus of the new entity ….

When no new capital is contributed, it can hardly be said that capital is being paid out in dividends, and this supports the argument that in a merger the earned surplus accounts of the predecessor companies may be continued.

There is general agreement that the first time the term “pooling of interests” was used to describe an accounting treatment was in connection with the February 1946 merger of Celanese Corporation of America and Tubize Rayon Corporation [Black, 1947, pp. 214-20]. A classic case of pooling of interests (although not referred to as such) took place, however, on September 30, 1936, when Universal Steel Company and Cyclops Steel Company merged into Universal-Cyclops Steel Corporation [Listing Application to New York Stock Exchange, April 14, 1937]. The merger was consummated through an exchange of equity shares whereby both the preferred and common stockholders of the constituent corporations became stockholders of the combined entity. One of the earliest uses of the term “pooling of interests” was in a Federal Power Commission case in 1943. The case involved two groups of properties held by different persons who desired to merge into one company in which both groups would be shareholders. Wyatt [1963, p. 22] states that the Commission ruled as follows:

… While it may be tolerable to allow a buyer to capitalize the purchase price he may have paid… there is surely nothing to be said in favor of allowing two companies mutually to pool their interests, and from that time for-ward to treat as vested the values they happened then to have.

Wyatt [1963, p. 23] clarified the use of the term at this period in time:

The term “pooling of interests” was used at this early date to describe a combination transaction between various interests in which these interests fused their divergent parts into one enterprise. The term was not used to describe the accounting treatment proposed; instead, the accounting treatment flowed from the manner in which the Commission viewed the transaction and its responsibility to maintain reasonable utility rates.

The concept of pooling of interests accounting apparently was an outgrowth of the discussions and transactions that took place during the 1920s, 1930s, and the early 1940s. “The earliest use of the term by an arm of the American Institute was in the report of the committee on public utility accounting which was presented to Council on May 1, 1945” [Wyatt, 1963, p. 23]. In discussing several accounting questions that had been proposed by the Federal Power Commission, the committee stated that one hypothesis which needed careful consideration was “that no new cost can result from a transaction that… may be regarded as effecting a pooling of interest” [American Institute of Accountants, 1946, p. 152]. From this first public recognition of the expression, the theory of pooling has evolved to that which is enunciated in APB Opinion No. 16.

The purpose of this paper is to trace the development of pooling of interests accounting for business combinations from 1945 to 1991. The history of the pooling concept is reviewed chronologically with particular emphasis on the events of 1969-1970 that were related to the most recent pronouncement on the subject, APB Opinion No. 16.

A CHRONOLOGY OF THE DEVELOPMENT OF POOLING

1945-1950

The period from 1945 to 1950 represented a transitional period, both in the methods used to accomplish business combinations and in the techniques used to account for them. A shift from combinations involving exchanges of assets to ones effected through exchanges of equity securities was evident. As this shift

Rayburn and Powers: A History of Pooling of Interests Accounting 159

was taking place, a formal distinction began to emerge between two types of combinations: (1) combinations where a strong de-gree of affiliation existed prior to the combinations, and (2) combinations where the constituents had no prior family type relationships and in which any existing affiliation was merely incident to normal business activities. It was during this period that the term “pooling of interests” became more closely related to an accounting treatment rather than a description of a type of business transaction [Wyatt, 1963, pp. 21-24].

During this time span, there were seven dates that are mile-stones in the development of pooling of interests accounting: (1) December 1944, (2) January 20, 1945, (3) June 7, 1945, (4) October 20, 1945, (5) February 1946, (6) February 1950, and (7) September 1950.

December 1944

The significance of this date is related to the publication of Accounting Research Bulletin (ARB) No. 24 [Committee on Ac-counting Procedure, 1944]. ARB No, 24 dealt with some of the problems involved in accounting for intangible assets. No refer-ence was made to pooling of interests, but in retrospect it may have marked the beginning of the need for a new method of ac-counting for business combinations.

ARB No. 24 was an initial step in the development of an official position on goodwill. It incorporated current practice into theory and classified intangible assets into type (a) and (b) as follows:

(a) Those (intangible assets) having a term of existence limited by law, regulation, or agreement, or by their nature (such as patents, copyrights, leases, licenses, franchises for a fixed term, and goodwill as to which there is evidence of limited duration).

(b) Those (intangible assets) having no such limited term of existence and as to which there is, at the time of acquisition, no indication of limited life (such as goodwill generally, going value, trade names, secret processes, subscription lists, perpetual franchises, and organization costs) [p. 1].

The cost of type (a) intangible assets was to be “amortized by systematic charges in the income statement over the period benefited.” Three alternatives were made available for recording the cost of a type (b) intangible: (1) write it off immediately against either paid-in capital or earned surplus, (2) systematically amor-tize it against revenues over its estimated remaining useful life, or (3) retain it on the corporate records for an indefinite period. Although a direct write-off of goodwill to capital or earned surplus was an acceptable treatment, the committee tried to discourage its use [ARB No. 24, p. 3].

In retrospect, this action probably gave impetus to the development of the pooling concept since pooling avoids the need to record goodwill. Up to this time, business combinations accomplished by any means could be accounted for as purchases with immediate write-off of the goodwill to capital or earned surplus. The effect was to eliminate goodwill from the records without affecting current or future reported earnings. The language used in ARB No. 24 implied that the winds of change were blowing and that the direct write-off procedure, although currently acceptable, would be given more attention in the future.
January 20, 1945

On this date, the Securities and Exchange Commission (SEC) issued Accounting Series Release (ASR) No. 50 [1945]. This document concerned the propriety of writing down goodwill by charging it to capital surplus. The SEC, through its Chief Accountant, William W. Werntz, took the position that henceforth no goodwill could be written off to capital surplus [ASR No. 50, p. 1].

Prior to this release, mergers could be arranged so that either no goodwill was created, or the goodwill could be charged directly to surplus, earned or capital. Spacek [1970, p. 40] stated that, faced with the declaration that goodwill could no longer be charged to capital surplus, corporate managements invented the term “economic merger” or “pooling of interests.” The pooling of interests method avoids the need to record goodwill because it is assumes that no new basis of accountability arises.
June 7, 1945

William W. Werntz, Chief Accountant of the SEC from May 1938 to April 1947, presented a paper on “Corporate Consolidations, Reorganizations, and Mergers” [1945, pp. 379-87]. Although the term “pooling of interests” was not used by Werntz, he did discuss methods of differentiating between two different types of business combinations.

Arguing against the thought that “specific accounting results follow automatically from the selection of a particular method of combination,” Werntz stated that more weight should be given to four factors as criteria or tests of the accounting to be followed:

(1) The relative size of the predecessors; that is, is one company so much larger than the other that it is obviously buying up a business rather than truly merging?
(2) The degree of affiliation among the predecessors.
(3) The extent to which there is a change in ownership in the course of the combination.
(4) The nature and extent of prior business relations between the two companies.

It was hypothesized that the application of these four criteria would be very useful to differentiate between mergers, consolidations or other forms of combinations that resulted in a new economic enterprise, and those that were in reality the continuance of an old business under a new corporate structure.
Two of Werntz’s four criteria were subsequently incorporated in Accounting Research Bulletin No. 40 as the basis to differentiate a purchase and a pooling of interests [Committee on Accounting Procedure, 1950].

October 20, 1945

As stated previously, the earliest use of the term “pooling of interests” by a committee of the American Institute of Accountants (AIA) was in the report of the Committee on Public Utility Accounting on May 1, 1945. More important, however, is the fact that after considering the report of the Committee on Public Utility Accounting, the Committee on Accounting Procedure wrote a letter to the executive committee stating “the committee assumes that the term ‘pooling’ as here used refers to a situation in which two or more interests of comparable size are combined and would not include a transaction by which the interests of a small company are combined with those of a company that is substantially larger” [Committee on Accounting Procedure, footnote 3, October 20, 1945]. Andrew Barr, Chief Accountant of the SEC from No-vember 1956 to January 1972, later said “this is the size test ap-plied by the SEC staff until the rug was pulled out from under us in Celanese” [Barr, May 17, 1979].

February 1946

This date marks the merger of Celanese Corporation of America and Tubize Rayon Corporation into Celanese Corporation of America [see Black, 1947, pp. 214-20]. Regardless of the fact that Tubize was only one-fifth the size of Celanese on the basis of total assets, and one-third as large on the basis of common stock equity, the combination was accounted for as a pooling of interests. At this early stage, four years before a committee of the AIA would formally recognize the pooling concept, the comparable size criterion was beginning to erode. Barr [1959, p. 178] reported later that “from this point on, relative size was considered to be less important than other factors in considering whether a business combination met the test for pooling of interests accounting.”

In Black’s [1947, p. 215] discussion of the Celanese/Tubize merger, he attempted to distinguish (as Werntz had earlier done) between two types of business combination transactions. Referring to the two types as “acquisitions” and “mergers” (later to be referred to as purchases and poolings of interests), he differentiated them by stating that in an acquisition, no ownership interests continue; whereas, “in a merger there is a pooling or commingling of the rights of the various security holders, the assets, liabilities, and operations of the merging corporations being combined, like with like, to the end that future operations of the continuing corporation can be carried on a combined basis with the attendant economies and other advantages.”
Black [1947, p. 215] suggested the following procedure for recording a true merger:

It seems clear that the application of sound accounting methods to a merger… results, except for any pre-exist-ing inter-company indebtedness, in the single arithmetical addition of assets, liabilities, and net worth. In general, the continuing corporation should arise from the merger with an earned surplus equal in amount to the sum of the earned surpluses of the constituent corporations.

Although Celanese was the dominant corporation in size, Black proposed two criteria: (1) comparative size and importance in the industry and (2) continuity of ownership interest. The importance of the Celanese/Tubize merger is reflected by the fact that ARB No. 40 later required the same accounting treatment for business combinations deemed to be poolings of interests, i.e., the book values and the retained earnings of the constituent companies are carried forward.

February 1950

An article by Wilcox [1950, p. 102] is typical of the state of confusion that existed with regard to accounting for business combinations at this point in time. As Werntz and Black had earlier done, Wilcox differentiated between a merger (pooling) and a purchase. To him, a merger took place “when the nature of a combination is a pooling of interests and there is no substance of buying and selling….
In a discussion of the criteria for a merger, it was suggested that relative size, continuity of ownership, and continuity of management were particularly important. While recommending that these criteria be established, Wilcox cautioned that they should be set up as guidelines for the professional accountant and not as rigid rules.

The mechanics of recording a merger were detailed. Included in the description was the concept that no new costs were created and that the earned surpluses of the combining firms should be joined, with adjustments to capital surplus and/or earned surplus contingent on the resulting relationship of the combined stated capital.

The unique contribution of this article relates not only to its similarity to ARB No. 40, which was published later in the same year, but also to the positions taken by Wilcox [1950, p. 106] with regard to the revaluation of assets in a merger, partial poolings, and earned surplus. While pointing out that no new costs are established in a merger, Wilcox also said that “a merger creates an especially appropriate occasion for any useful revaluation for which there exists authoritative accounting support applicable in the circumstances.”

The earliest reference in the literature to a part-purchase, part-pooling is found in this article. First, the author takes the position that the accounting treatment for mergers and purchases should be mutually exclusive. He then relents this position by indicating that “in some cases, however, a combination may involve both the aspects of a purchase and a merger” [p. 106].

Arguing that the net balances of earned surplus should be combined in a pooling of interests, Wilcox suggested that “it seems unnecessary for any company to become a party to a merger with the handicap of an operating deficit” [pp. 105-6]. In a merger where this condition might prevail, he suggested that the party or parties with an operating deficit should go through a quasi-reorga-nization before the combination is effected [pp. 105-6].

September 1950

Accounting Research Bulletin No. 40 formalized pooling of interests accounting. For the first time, a committee of the American Institute of Accountants used the terms “pooling of interests” and “purchase” to describe two types of business combinations. The bulletin included a discussion of the criteria for a pooling of interests and the accounting treatment to be used [Committee on Accounting Procedure, 1950].

Criteria

Four criteria were presented in ARB No. 40 to assist the professional accountant in evaluating whether a business combination was a pooling of interests: (1) continuity of ownership interest, (2) relative size of the constituents, (3) continuity of management or the power to control management, and (4) nature of business activity (similar or complementary activity would support a presumption of pooling) [pp. 1-2].

A pooling of interests was characterized as a business combination in which “all or substantially all of the equity interests in predecessor corporations continue as such, in a surviving corporation which may be one of the predecessor corporations, or in a new one created for the purpose” [p. 1]. The relative size criterion was not specifically defined, but the language in the bulletin indicated that pooling of interests would probably not be applicable if one of the constituents was minor in size in relation to the others. With regard to application of the criteria, ARB No. 40 stipulated that “no one of these factors would necessarily be determinative, but the presence or absence would be cumulative in effect” [pp. 1-2].

Accounting Treatment

In addition to establishing the criteria for a pooling of inter-ests, ARB No. 40 was specific about the accounting procedure to be used. For the first time, a committee of the AIA sanctioned the carrying forward of the retained earnings of an acquired firm into the records of the acquiring firm. If the combination was to be treated as a pooling of interests, it was necessary to use the following accounting procedures:

When a combination is deemed to be a pooling of interests, the necessity for a new basis of accountability does not arise. The book values of the assets of the constituent companies, when stated in conformity with generally accepted accounting principles and appropriately adjusted when deemed necessary to place them on a uniform basis, should be carried forward; and the retained incomes of the constituent companies may be carried forward ….

Due to the variety of conditions under which a pooling of interests may be carried out, it is not practicable to deal with the accounting presentation except in general terms. A number of problems will arise. For example, the aggregate of stated capital of the surviving corporation in a pooling of interests may be either more than, or less than, the total of the stated capital of the predecessor corporations. In the former event the excess should be deducted first from the aggregate of any other contributed capital (capital surplus), and next from the aggregate of any retained income (earned surplus) of the predecessors; while in the latter event the difference should appear in the balance-sheet of the surviving corporation as other contributed capital (capital surplus)… [p. 2].

Prior to the issuance of ARB No. 40, there had been a few business combinations that were recorded as poolings. Subse-quent to 1950, the modern merger movement accelerated and pooling of interests accounting was used more frequently.

1950-1960

In the ten-year period following the publication of ARB No. 40, the American Institute of Accountants (name changed to American Institute of Certified Public Accountants [AICPA] in 1957) issued two additional accounting research bulletins related to accounting for mergers. The dates of these official pronouncements were June 1953 and January 1957.

June 1953

Accounting Research Bulletin No. 43 was an attempt to codify and to clarify the portions of the first forty-two bulletins that had continuing value. Two chapters of this publication were related to the evolution of the theory of pooling: (1) Chapter 5, “Intangible Assets,” and (2) Chapter 7, Section C, “Business Combinations” [Committee on Accounting Procedure, 1953].

ARB No. 43. Chapter 5

As a restatement of ARB No. 24 , the only significant change in this chapter was the elimination of one alternative treatment of type (b) intangibles. The superseded bulletin had discouraged the practice of writing off type (b) intangibles directly to earned or capital surplus, but it had not prohibited the procedure.

Under ARB No. 43, the alternatives were either to carry the type (b) intangible on the books for an indefinite period or to amortize it against income. When such an intangible became worthless, a direct write-off could be made to income or if the inclusion of substantial charges to income would tend to be misleading, a charge directly to earned surplus was acceptable. Under no circumstances was purchased goodwill to be immediately charged to capital surplus [pars. 6-8]. Since the SEC had stated in ASR No. 50 (see previous discussion) that goodwill could not be charged to capital surplus, the Committee on Accounting Procedure apparently was bending to the regulator’s will on this issue.

ARB No. 43. Chapter 7, Section C

With one exception, this chapter was a rewording of ARB No. 40. The new concept was that “when a combination results in carrying forward the earned surpluses of the constituent companies, statements of operations issued by the continuing business for the period in which the combination occurs and for any preceding period should show the results of operations of the combined interests” [par. 7].

This procedure is consistent with the basic concept that a pooling of interests is simply a combination and continuation of two or more firms as a single entity. It is significant because it is the first time that the manner of presenting earnings under the pooling concept had been set forth.

January 1957

Chapter 7, Section C of ARB No. 43 was supplanted by ARB No. 48 [Committee on Accounting Procedure, 1957]. To make pooling of interests accounting more compatible with the growing trend toward corporate diversification, the requirement of similar or complementary businesses was deleted. The tests of continuity of ownership and continuity of management or the power to control management were retained.

Prior to 1957, the relative size criterion had never been specifically defined, but there was apparently an understanding that only firms of relatively equal size could be pooled. This position had been under attack from the business community and little support had been received by the profession from the SEC in enforcing the rule. ARB No. 48 attempted to illuminate the relative size question by stating that “relative size of the constituents may not necessarily be determinative, especially where the smaller corporation contributes desired management personnel; however, where one of the constituent corporations is clearly dominant (for example, where the stockholders of one of the constituent corporations obtain 90% to 95% or more of the voting interest in the combined enterprise), there is a presumption that the transaction is a purchase rather than a pooling of interests” [par. 6]. Barr [May 17, 1979] said that “Paragraph 6 of ARB No. 48 by specifying a 90% to 95% voting interest completed destruction of the size test. About this time, the New York Stock Exchange left enforcement to the accounting profession and obtained letters from them stating their satisfaction with the rules.”

In addition, ARB No. 48 initiated the concepts of continuity of assets and continued subsidiary existence after a pooling of interests. Statements on these two subjects were as follows:

… abandonment or sale of a large part of the business of one or more of the constituents militates against considering the combination as a pooling of interests [par. 6].

… the continuance in existence of one or more of the constituent corporations in a subsidiary relationship to another of the constituents or to a new corporation does not prevent the combination from being a pooling of interests … [par. 4].

The practical effect of this bulletin was that essentially any business combination could be accounted for as a pooling, regardless of the types of businesses or the relative sizes of the combining firms. Speaking at the annual meeting of the American Accounting Association (AAA) in 1958, Barr [1959, p. 179] confirmed that relative size was no longer a significant factor.

As a general proposition we have objected to pooling of interests when the equity of the smaller company would be less than five percent. However, in some situations pooling of interests accounting has been accepted when the acquiring company’s interests has exceeded 95 percent ….

1960-1968

Pooling of interests accounting was never approved as an optional method in either ARB No. 48 or any of the previous pronouncements of the American Institute of Accountants, but it was clearly treated as such in practice. If a business combination met the requirements for a pooling, it could be treated either as a pooling or as a purchase. As the attributes prerequisite to a pooling diminished, either by proclamation or in practice, the effect was that by 1960 almost any merger could be accounted for as a pooling.

The appropriateness of using pooling of interests accounting was the leading accounting controversy of the 1960s because it was widely believed that pooling accounting might artificially stimulate merger activity, encourage corporations to issue excessive debt or preferred stock securities, or mislead investors [Seligman, 1982, p. 420]. By the early 1960s, the ability to increase earnings per share by use of pooling accounting was being recognized publicly [Chatov, 1975, p. 213]. This phenomenon could be achieved by (1) the sale of assets acquired (in a pooling, assets acquired would be recorded at book value with the subsequent sale at market value yielding an instant gain); (2) the pooling of earnings while reducing the number of shares of common stock outstanding (by paying for part of the acquisition with cash, debt securities or preferred stock); and (3) lower reported depreciation and amortization due to assets being recorded at book value (as-suming book value was lower than market value).

As the post-World War II merger movement picked up steam, the controversy over accounting for business combinations increased. In 1959, the Committee on Accounting Procedure was superseded by the Accounting Principles Board (APB). With a renewed emphasis on research to find solutions to accounting issues, the APB funded two research studies related to merger accounting. In the 1960s, the topic was mentioned, in conjunction with other issues, in two opinions issued by the APB and the APB formed a committee to study accounting for business combinations. Also, a committee of the AAA recommended that pooling of interests accounting be discontinued. During this time period, six dates are significant: (1) July 1963, (2) October 1965, (3) July 1966, (4) December 1966, (5) January 1968, and (6) October 1968.

July, 1963

Accounting Research Study (ARS) No. 5, “A Critical Study of Accounting for Business Combinations,” was published by the AICPA [Wyatt, 1963]. Wyatt said, “In the study of business combinations we are primarily concerned with the accounting concepts to be used as guides in recording the effects of financial transactions and with the nature of informative disclosures in the financial statements” [p. 11].

After a study of the literature and a review of over 350 business combinations consummated between 1949 and 1960, Wyatt concluded that the criteria used to differentiate a pooling of interests from a purchase were artificial guidelines and that there had been a gradual deterioration in the criteria. With regard to the size criterion, he found that “the vast majority of business combinations consummated in recent years involved constituents of disproportionate size” [p. 73]. Wyatt further determined that “at the same time the pooling concept has become predominant in accounting for business combinations consummated by transfer of capital stock” [p. 73].

Although there are nine recommendations in the research study, they can be reduced to the following four general suggestions: (1) pooling of interests accounting is a valid concept only in cases where there is a combination between two legally separate, but closely related entities; (2) the vast majority of business combinations are exchange transactions and should be accounted for as purchases; (3) goodwill should be amortized over its expected limited life, or if it does not appear to have limited life, it should be carried forward until evidence of its impairment exists; and (4) “fair-value pooling” should be used when the combining entities are about the same size and it is impossible to determine which one acquires the other [pp. 105-7],

Speaking on behalf of the Project Advisory Committee for ARS No. 5, Maurice Moonitz, Director of Accounting Research for the AICPA, made the following statement:
The committee is of the opinion that Professor Wyatt’s study is good insofar as it relates to background mate-rial and general discussion, but some members feel that its conclusions and recommendations are not realistic and do not give adequate recognition to other points of view. The study seems to favor a discontinuance of al-most all poolings of interests. The committee feels that the distinction between poolings and purchases should be continued .. . Also, the committee is not disposed to accept the fair value approach to combinations of com-panies of approximately equal size [Wyatt, 1963, p. xiii].

Wyatt’s conclusions were based on the concept that a busi-ness combination is essentially a particular type of business transaction [Wyatt, 1963, p. 69]. Moonitz wanted to know the practical consequences of defining a business combination as occurring “when two or more companies merge their assets or place them under common ownership or control by any one of a variety of methods” [Wyatt, 1963, p. xii]. Robert C. Holsen agreed to study this issue and his report “Another Look at Business Combinations” is included in ARS No. 5 [Wyatt, 1963, pp. 109-14].

Moonitz said, “I concur with his [Holsen’s] conclusions that ‘.. . a purchase occurs when … one group … gives up its owner-ship interest in the assets it formerly controlled,’ that ‘… a pool-ing occurs when equity shares are exchanged …’ and that ‘criteria such as relative size and continuity of management…’ are neither logical nor practical guides to a distinction between a purchase and a pooling” [Wyatt, 1963, p. xii]. Holsen also “suggested that the accounting policy with respect to the write-off of goodwill should be re-examined and consideration given to allowing a company to charge to earned surplus the amount of goodwill at the date of its acquisition” [Wyatt, 1963, p. 114]. Moonitz did not embrace Holsen’s suggested accounting for goodwill, but did agree that the issue needed to be re-examined.

October 1965

After a review of all Accounting Research Bulletins issued prior to December 31, 1965, the APB issued Opinion No. 6 [1965]. One paragraph in this Opinion related to accounting for business combinations. As a modification of ARB No. 48 the following statement was made:

The board believes that Accounting Research Bulletin No. 48 should be continued as an expression of the general philosophy for differentiating business combinations that are purchases from those that are pooling of interests but emphasizes that the criteria set forth in paragraphs 5 and 6 are illustrative guides and not necessarily literal requirements [par. 22].

At this point, continuity of ownership was the only surviving major criterion for pooling.

July 1966

Erosion of the criteria for a pooling of interests and the in-creasing popularity of the concept did not silence the theoretical debate, however. In fact, less than a year from the date that APB Opinion No. 6 was issued, the American Accounting Association’s Committee to Prepare a Statement of Basic Accounting Theory, in its publication A Statement of Basic Accounting Theory [1966, p. 33], recommended that pooling of interests be disallowed.

December 1966

APB Opinion No. 10 amended paragraph 12 of ARB No. 48. The requirements for restatement of financial statements after a pooling of interests were amplified with the most significant change being that “if the pooling is consummated at or shortly after the close of the period, and before financial statements of the continuing business are issued, the financial statements should, if practicable, give effect to the pooling for the entire period being reported…” [par. 5].
The practical result of this requirement was to make it pos-sible for a firm to manipulate its reported earnings. By having a merger ready to be effected, management could wait to see what its earnings were for the prior period before determining when to finalize the agreement. If earnings for the prior period were inadequate, the pooling of interests could be consummated and the combined financial results for the prior period would be reported as if the two firms had been operating as one for the entire prior period. On the other hand, if earnings for the prior period for the acquiring firm met management’s expectations, the merger could be postponed for completion in the following period. Instead of clarifying and strengthening the theory of pooling, APB Opinion No. 10 created another loophole that would embarrass the profession.

January 1968

During the decade of the 1960s, pressure had been exerted upon the accounting profession to accept the pooling of interests treatment for a business combination even though the evidence clearly indicated that the transaction was a purchase. With the apparent consent of the SEC, the concept of part-purchase, part-pooling had been accepted [Kellogg, 1965, p. 34] ; the relative size criterion had become meaningless [Eiteman, 1967, p. 4]; retroactive poolings had been effected [Mosich, 1968, pp. 352-62]; various types of securities, other than common stock, had been used [Kellogg, 1965, pp. 36-7]; and pooling accounting had assumed a passive role, i.e., management could apparently elect or reject pooling if the terms of the merger met minimum criteria.

The literature of the 1960s was replete with discussions both supporting and opposing pooling [see, for example, Blough, 1960; Briloff, 1967; Jaenicke, 1962; Lauver, 1966; Mosich, 1967; and Sapienza, 1962.] Under mounting pressure, the APB formed a committee on business combinations. It would be almost three years before an opinion would be issued, but this date marked the beginning of a long, arduous effort to establish sound accounting principles applicable to business combinations.

October 1968

The subject of goodwill has had a profound influence on accounting for business combinations. When ARS No. 5 [Wyatt, 1963] was published, the APB recognized the inter-relationship of these two topics, and subsequently authorized a study of goodwill which was to be completed before a serious effort was made to establish new accounting rules for business combinations.

In general, the recommendations of ARS No. 10 [Catlett and Olson, 1968] were consistent with ARS No. 5. Having concluded that most business combinations should be accounted for as purchases and that the difference between the value of the consideration given and the fair value of the net assets acquired should be assigned to goodwill, the authors disagreed with Wyatt regarding the disposition of goodwill. Catlett and Olson took the position that goodwill resulted from a disbursement of assets or of proceeds of stock issued to effect the business combination, in anticipation of future earnings, and that it should, therefore, be accounted for as a reduction of stockholders’ equity rather than as a charge to income [1968, p. xii].

ARS No. 10 was criticized by five members of its Project Advisory Committee [pp. 116-54] and by Reed K. Storey, AICPA Director of Research [pp. xi-xiii, pp. 162-6]. Storey criticized the research methodology and suggested that the conclusions were not supported by logic. Only one member of the Project Advisory Committee, Leonard Spacek, strongly supported the authors’ conclusions [pp. 155-61].

1969-1970 — APB OPINION NO. 16

Although the APB subcommittee on business combinations had been appointed in January 1968, the committee deferred action toward developing an opinion until ARS No. 10 was released late in 1968. The combined recommendations of ARS No. 5 and ARS No. 10 were used as reference points for the initial exploration of the subject of accounting for mergers. Thus, most of the activity associated with the development of APB Opinion No. 16 took place in 1969 and 1970.

The crisis with which the accounting profession would wrestle over this two-year period was a product of two phenomena. In testimony before the Senate Commerce Committee, Hamer H. Budge, Chairman of the SEC, pointed out that total mergers in 1968 were twelve times the 1950 level, three times the 1960 level, and one and one-half times the level of 1967 [United States Senate, 1969, p. 29]. Commenting on the extremely complex capital structures which are often created in a merger, Budge said that “we have felt that improvements are needed in accounting practices as applied to conglomerates in order to provide more meaningful information for investors and the securities markets” [United States Senate, 1969, p. 33].

Not only was the rate of merger activity increasing, the use of pooling of interests accounting for business combinations was also increasing. Wakefield [1970, p. 33] reported that of 391 Listing Applications to the New York Stock Exchange that related to the issuance of stock for merger or acquisition purposes, 82.5 percent were accounted for as poolings of interests. Analysis of Listing Applications to the New York Stock Exchange for the twelve-month period beginning with November 1, 1968, and ending with October 31, 1969, confirms Wakefield’s figures. Of a total of 2,200 Listing Applications that were filed during the above period, 1,087 involved proposed business combinations. Pooling of interests accounting was proposed and approved for 82.98 percent of the applicants [Rayburn, 1975, p. 9].

Buttressed by relaxation of the criteria for pooling in APB Opinion No. 10 and apparently supported by the regulatory bodies involved, accounting practitioners had, with few exceptions, reached the point where they were willing to approve any combination as a pooling, if management of the acquiring firm could get approval from the SEC. One of the vociferous critics of pooling, Briloff [1967, p. 489], had earlier characterized the situation.

While the Board (APB) is considering the entire subject of business combinations (while explicitly continuing its dispensation for the pooling method) the process of shareholder delusion through share dilution continues unabated. It can, in my opinion, be fairly inferred that this delusion-dilution process goes on with the specific approval, and probably also the guidance, of the independent auditors for the acquiring entity, and with the direct knowledge and consent of the Securities and Exchange Commission, as well as the committees on stock listing for the several exchanges including The New York
Stock Exchange.

In this review of the development of APB Opinion No. 16, the major events are listed chronologically with some deviations deemed necessary for clarity. In an effort to capture the mood of the times and the pressure under which accounting theory is determined, the activities related to APB Opinion No. 16 are dis-closed in more detail than previous and subsequent developments. Thus, numerous dates are involved and are revealed. To follow the established procedure of developing each date as a sub-topic, however, would tend to clutter rather than create order. Therefore, the structure of this section is modified.

Early in 1969, the SEC began to express its concern over the “gamesmanship of corporate acquisitions and earnings per share” [Barr, March 21, 1969]. Barr, then Chief Accountant of the SEC, made some suggestions as to what might be acceptable to the SEC on pooling of interests accounting.

1. Only an exchange of unissued common stock or convertible preferred stock, which meets the definition of a common stock equivalent in APB Opinion No. 15, for
the common shares or net assets of the company to be acquired should qualify as a pooling. Partial poolings should be discontinued.
2. The combination should be a tax-free reorganization.
3. The relative size test must be reinstated and a test of two to one was suggested.
4. The combination should be of going concerns operating in corporate form.

In addition to favoring the continuation of the concept of pooling, the SEC stated that “amortization of purchased goodwill should be mandatory” and suggested a maximum period of thirty to thirty-three years. From this time forward, the major controversy would be centered on pooling or no pooling, the size test, and mandatory amortization of goodwill.

In June 1969, the APB invited representatives of cooperating organizations to a symposium on business combinations which was held in New York [Lytle, June 3, 1969]. A second symposium was held in October 1969. From these early discussions, it was evident that opinion was divided. In favor of the pooling of interests concept were the American Bar Association, the Financial Analysts Federation, the Financial Executives Institute (FEI), Robert Morris Associates, and the SEC. Even among this group, however, there was an apparent consensus that pooling should be restricted to business combinations meeting specific criteria.

Although there was mixed reaction from outside organiza-tions as well as from within the APB, early sentiment on the Board was to discontinue pooling of interests accounting. Commenting on a draft opinion that called for the discontinuance of pooling and the mandatory amortization of purchased goodwill, Barr [October 8, 1969] urged retention of the pooling concept. Two Big-Eight accounting firms made known their opposition to this draft and the Corporate Reporting Committee of FEI initiated a vigorous campaign against elimination of pooling of interests accounting [Zeff, 1972, p. 214]. Indication of an early shift in the APB’s position appeared in an AICPA press memorandum [October 28, 1969].

At a meeting last weekend, the Accounting Principles Board affirmed the position that acquisitions should be accounted for as purchases. It is exploring the proposi-tion that in transactions involving common stock only, goodwill would not be recognized because of the diffi-culty of determining a reliable total cost based on market price of the common stock issued.

In December 1969, two contrasting positions were made public. On the eighth of the month, the AICPA released a press memorandum in which the APB took a tentative position favoring purchase and pooling of interests accounting, but not as alternatives. The pooling method would be retained only for common stock transactions that met certain criteria, one of which would be that neither party to the business combination could be more than three times as large as the other. Prior to the APB’s tentative decision, the Federal Trade Commission, in hearings before the Subcommittee on Antitrust and Monopoly of the U. S. Senate Committee on the Judiciary, recommended that the SEC require that pooling of interests be eliminated “as the normal mode of accounting for acquisitions involving the exchange of stock” [Federal Trade Commission, 1969, p. 23].

Exposure Draft

Operating within this environment, the APB [February 23, 1970], after eight discussion drafts, released an Exposure Draft of the proposed opinion on accounting for business combinations and intangible assets. Over 40,000 copies of the Exposure Draft were distributed for comment to corporate executives, government and stock exchange officials, security analysts, and members of accounting faculties and public accounting firms [AICPA, March 2, 1970].

In the Exposure Draft, the APB took the position that the purchase method and the pooling of interests method of accounting for business combinations were acceptable, but not as alternatives. If a merger met specific criteria, it would have to be accounted for as a pooling of interests. Failure to meet any one of the criteria would dictate the use of purchase accounting [par. 7].

On the related issue of purchased goodwill, the APB stated that the cost should be amortized over the estimated useful life of the asset with the period of amortization not to exceed forty years [par. 106].

General Criticism

The general criticism of the proposed opinion was that the APB was trying to restrict mergers rather than establish sound accounting principles for business combinations. An example of this reaction was a statement by Jules Backman [1970, p. 46], an economist, that “we should not attempt to limit acquisitions by big companies through changes in accounting methods.” Herbert C. Knortz [1970, p. 30], senior vice-president and controller of International Telephone and Telegraph Corporation (ITT), commented as follows:

A statement of principle acknowledging the basic validity of both the poolings and the purchasing concepts, as the draft does, would have been well advised to avoid paying only lip service to one of these techniques. This admonition is of significant importance when one realizes that the accounting disadvantage generated by the purchasing treatment is so massive it makes most mergers economically untenable.

Many investment bankers and corporate financial officials joined the chorus to predict that the proposed rules would sharply curtail the merger movement [ Wall Street Journal, February 27, 1970, p. 1].

Support was also evident, however. On two occasions, Hamer H. Budge, Chairman of the SEC, endorsed the proposal before Congressional Committees [Wall Street Journal, June 24, 1970, p. 7]. In a speech before the National Association of Accountants,

Rayburn and Powers: A History of Pooling of Interests Accounting 177
SEC Commissioner James Needham [1970] said that “we encouraged the APB to include in this proposed opinion the very restrictive criteria for the use of pooling-of-interests accounting and the requirement for mandatory amortization of goodwill arising in purchase transactions.” Both the New York Stock Exchange and the American Stock Exchange endorsed the draft [ Wall Street Journal, June 24, 1970, p. 7].

Particular criticism was leveled at two provisions of the draft: (1) the size test and (2) mandatory amortization of goodwill.

Size Test

The Exposure Draft would have allowed pooling of interests only in cases where the acquiring company was no greater than three times as large as the acquired firm. Relative size was to be determined at the date the merger was consummated by computing the ratio of the number of shares of voting common stock issued to the acquired firm’s stockholders to the total outstanding shares. The following quotations are illustrative of the attacks lodged against this requirement:
It is difficult to understand conceptually why pooling is appropriate for an acquisition more than one-third the size of the acquiring company but not appropriate for a company which is relatively smaller [Backman, 1970, p. 42].

FEI (Financial Executives Institute) considers the size criterion contemplated in this exposure draft to be discriminatory and conceptually indefensible. FEI had, in previous discussions with the APB, expressed a willingness to compromise on principle and accept a 10% (or 9 to 1 ratio).. . However, in the light of more deliberate and more complete discussion of this issue, which suggests that such a compromise could virtually eliminate poolings of interests, FEI’s latest position reaffirms our belief that a size criterion is neither valid nor practical [Hangen, 1970].

The proposed opinion contains many controversial is-sues, but none so patently improper as the suggested “size test.” … Research by the Financial Executives Institute has indicated that less than five percent of the mergers in its sampling would have qualified for pooling under the proposed tests. An examination of 63 indicates that only one would have qualified [Knortz, 1970, p. 30].

In an effort to still speculation over the effect of the proposed size test, two members of the APB conducted independent research on the subject. One limited survey of 293 mergers revealed that “only 6% of the poolings reviewed involved combinations meeting the proposed size criterion” [Watt, 1970]. The other study of 1,452 cases of business combinations involving the offering of stock during 1969 indicated that only five percent would qualify for pooling under the three-to-one size test [Catlett, 1970].

Mandatory Amortization of Purchased Goodwill

The mandatory amortization of purchased goodwill over a period not to exceed forty years has the effect of reducing reported earnings. Opposition to this proposed requirement ranged from the theoretical argument that goodwill should not be recognized as an asset [Arthur Andersen & Co., 1970] to the more practical argument that the rule would reduce the incentive for mergers by cutting the post-merger earnings reported by the combined entity.
In a research study that was financed by the Financial Executives Research Foundation, with the expressed purpose of influencing the deliberations of the APB, Burton [1970, p. 82] reported the results of his survey as follows:

It was also demonstrated that the amortization of good-will acquired in 1967 mergers over a 40 year period would only slightly reduce reported earnings in the years 1968 and 1969. At the same time, the impact of 40 year goodwill amortization on the incremental earnings produced by business combinations in the same companies would have been much more significant, averaging approximately 50% of the earnings acquired in the first year following the combination with considerable variation about the mean.

Overwhelming Opposition

The APB expected strong opposition to the proposed opinion, but whether the degree of resistance that materialized was expected is questionable. Zeff reports, “Early in the exposure period, the chairman of the FEI Corporate Reporting Committee again sent a letter to FEI members urging them to transmit their views to the APB as individuals and through their professional and trade associations” [1972, p. 214]. Ernst & Ernst and Arthur Andersen & Co. publicly opposed the draft and at least three other major public accounting firms quietly lobbied against it [ Wall Street Journal, June 24, 1970, p. 7]. Also, a coalition of business leaders, the Organization for Consistent Accounting Principles, waged a letter writing campaign against the proposal [Seligman, 1982, p. 423].

By June 1970, in addition to comments in the literature and in the press, the APB had received 860 letters of comment. Eighty-nine percent of the respondents expressed disagreement with the proposed opinion. Of this group, sixty percent were opposed to the restrictions on the use of pooling of interests accounting, and ten percent were against mandatory amortization of purchased goodwill. The only significant support for the draft came from accounting educators and the stock exchanges [Lytle, June 17, 1970].

Size Test is Relaxed and Agreement is Reached

At a meeting in June, the APB voted 12 to 6 to change the size test to nine-to-one and to require amortization of goodwill over a period not to exceed forty years. This vote was intended as final and a meeting was scheduled for one month later to approve the final wording of the opinion [Zeff, 1972, p. 216].

APB Opinion No. 16 and No. 17

At the meeting of the APB in July, the two-thirds majority could not be sustained and the Board was in a difficult position. Failure to reach a consensus would surely set the stage for the SEC to issue its own rule. Leonard Savoie, Executive Vice President of the AICPA, had warned “if the Board doesn’t correct abuses in merger accounting, the SEC will do the job swiftly and sharply” [Wall Street Journal, June 24, 1970, p. 7].

Unable to get a two-thirds vote on the proposed opinion (after several attempts), the APB divided the contents of the Exposure Draft into two opinions (one on business combinations and one on intangible assets) and agreed to eliminate the size test [AICPA Press Memorandum, July 31, 1970]. A two-thirds majority on separate opinions was possible because members of the APB held different views about APB Opinion No. 16 and No. 17. Milton M. Broeker, J. S. Seidman and Frank T. Weston voted against APB Oninion No. 16, but voted affirmatively for APB Opinion No. 17. George R. Catlett and Charles B. Hellerson dissented on APB Opinion No. 17, but supported APB Opinion No. 16. APB members Leo E. Burger, Sidney Davidson and Charles T. Horngren dissented on both opinions. APB Opinion No. 16, “Business Combinations,” passed by a vote of 12 to 6 and APB Opinion No. 17, “Intangible Assets,” was approved 13 to 5. The effective date of both opinions was November 1, 1970.

APB Opinion No. 17

Although this paper is primarily concerned with pooling of interests accounting, APB Opinion No. 17 is related. The signifi-cant aspect of this opinion, as it relates to accounting for business combinations, is the treatment of purchased goodwill. Buoyed by the support of the SEC, the APB did not budge from the position that purchased goodwill should be amortized against income over a period not to exceed forty years [par. 29]. Even if one agrees that this approach is theoretically sound in a purchase transaction, one must also acknowledge that the practical effect might be increased pressure to use pooling of interests.

APB Opinion No. 16

Even after the proposed opinion was divided into two parts, APB Opinion No. 16 on business combinations received only the bare two-thirds vote required for adoption. As stated above, the size test requirement was eliminated. Thus, the original concept of comparable size, which had become meaningless by the early 1950s, was not to be resurrected. The pooling concept, although apparently restricted, had survived.

In a move to counter the criticism that corporations could account for business combinations by the accounting method of their choice—pooling of interests; purchase; part-purchase, part-pooling—and to establish sound accounting principles that would eliminate other abuses that had been associated with accounting for mergers, the APB issued APB Opinion No. 16. Effective with merger negotiations initiated after October 31, 1970, the opinion approved both the purchase method and the pooling of interests method, but not as alternatives [pars. 8 and 97].

Under the new rules, some abuses were directly eliminated; minimum criteria were established that must be adhered to if a merger is to be treated as a pooling; and the accounting procedure for a pooling of interests was specified.

Abuses eliminated. — APB Opinion No. 16 attacked the past practice of part-purchase, part-pooling in a very direct manner. The Board said that “a single method should be applied to an entire combination; the practice now known as part-purchase, part-pooling is not acceptable” [par. 43]. There was one exception to this position, however. A “grandfather” clause applied if a mi- nority interest or exactly fifty percent was held in the common stock of another company on October 31, 1970, and after that date, the two companies enter into a plan of combination. Otherwise, such a situation could result in a part-purchase, part-pooling. Initially, this clause was to expire October 31, 1975 [par. 99]. However, in October 1975, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 10, “Extension of ‘Grandfather’ Provision for Business Combinations,” in which the five-year limitation was eliminated. At that time, the FASB had a project on its agenda titled “Accounting for Business Combinations and Purchased Intangibles” which involved a reconsideration of APB Opinion No. 16. Rather than leave open the possibility that accounting practices that would change with expiration of the grandfather provisions of APB Opinion No. 16 might change again after reconsideration of the opinion, the Board eliminated the five-year limitation “so as to maintain the status quo during the Board’s reconsideration of that Opinion” [FASB Statement No. 10, par. 3].

The practice of including the profits of an acquired company in the annual report to the stockholders even though the pooling took place after the end of the period reported on also was eliminated [par. 61]. This maneuver, made possible by a loose interpretation of the reporting requirements of APB Opinion No. 10, led critics to refer to it as a method of creating “instant earnings.” Corporate managements no longer have the alternative of using this ploy to enhance earnings reports.

The continuity of ownership rule was prevalent as a requirement for pooling in the pre-APB Opinion No. 16 era. Although never stated as a definite policy, the unwritten rule of the SEC was that control-selling shareholders (shareholders controlling the acquired company) could sell only twenty-five percent of the securities received within one year following the distribution of stock to them, twenty-five percent more the second year, and the balance after the two-year period had expired [Gunther, 1973, p. 459]. APB Opinion No. 16 contained no mandatory holding period for common stock received in a pooling. Therefore, immediate bail-outs of stock received were not damaging to a pooling. After some astute managements abused this privilege to the point of arranging to-tally “risk-free” poolings, the SEC issued Accounting Series Release No. 130 and No. 135 which required that “no affiliate of either company in the business combination sells or in any other way reduces his risk relative to any common shares received in the business combination until such time as financial results covering at least 30 days of post-merger combined operations have been published” [Gunther, 1973, p. 460]. This requirement is not as stringent as the old SEC rule, but it does emphasize the concept that a pooling implies continuity of ownership.

Minimum criteria. — Having accepted the validity of the pooling of interests concept, the APB stipulated that twelve criteria must be met if a business combination is to be treated as a pooling. Equally significant, perhaps, was the concept that if these criteria were satisfied, pooling must be used [par. 45].
Accounting procedure. — The method of recording a busi-ness combination as a pooling of interests is supported by the argument that no new basis of accountability arises. The accounting procedures set forth in APB Opinion No. 16 were consistent with this concept.
The combined corporation records the historical-cost based amounts of the assets and liabilities of the separate companies because the existing basis of accounting continues [par. 117].

The stockholders’ equities of the separate companies are also combined … The combined corporation records as capital the capital stock and capital in excess of par or stated value of outstanding stock of the separate companies.

Similarly, retained earnings or deficits of the separate companies are combined and recognized as retained earnings of the combined corporation. The amount of outstanding shares of stock of the combined corporation at par or stated value may exceed the total amount of capital stock of the separate combining companies; the excess should be deducted first from other contributed capital and then from the combined retained earnings …[Par. 118].
1971-1991

APB Opinion No. 16 attempted to identify those business combinations to be accounted for as poolings of interests by delineating the twelve pooling criteria and making the pooling versus purchase decision a somewhat mechanical one through strict consideration of those criteria. As companies began to apply the opinion in practice, application problems became apparent. In addressing problems of implementation, the AICPA issued thirty-nine interpretations of APB Opinion No. 16 between December 1970 and March 1973, dealing primarily with the specifics and mechanics of applying the pooling criteria.

The SEC also took action during 1972 and 1973 to provide implementation guidelines for APB Opinion No. 16. In addition to Accounting Series Release No. 130 and No. 135, the SEC issued Accounting Series Release No. 146, dealing with the effect of treasury stock transactions on accounting for business combinations. Many of the large accounting firms developed manuals providing guidance in applying APB Opinion No. 16. (See, for example, Interpretations of APB Opinion No. 16 and 17, Arthur Andersen & Co., Seventh Edition, 1988.) In discussing the need for extensive interpretive materials concerning the opinion, Dieter [1989] of Arthur Andersen & Co. states that “this must say something about the ambiguity of the concept of pooling-of-interests to accountants. Soundly conceived concepts are more easily understood and interpreted shortly after adoption” [p. 46].

Dieter also discusses the position generally taken by the SEC regarding poolings. He notes that the SEC has attempted to support the standard-setting authority of the private sector in recent years and its own rules have addressed relatively narrow issues where abuses were perceived, with one exception—interpreting APB Opinion No. 16.

… the Chief Accountant’s Office does not often issue SABs [Staff Accounting Bulletins] or other interpretative guidance on pooling-of-interests issues. Rather, pooling-of-interests accounting questions for registrants are handled on a case-by-case approach, and word of mouth is supposed to make these views available to the profession as a whole [Dieter, 1989, p. 47].

In 1973, the FASB replaced the APB as the primary accounting standard-setting body in the United States. Soon after its formation, the FASB issued an open letter soliciting the public’s views concerning the need for interpretation, amendment, or replacement of existing pronouncements of the Committee on Accounting Procedure or the Accounting Principles Board. The FASB Status Report dated April 30, 1974, indicated that a high proportion of the respondents to the open letter questioned APB Opinion No. 16 and No. 17. As a result, the FASB announced the appointment of a task force for a project on business combinations and purchased intangibles, with its first step to be reconsideration of the criteria for pooling of interests accounting. The primary objective of the task force was to provide input to the FASB in drafting a discussion memorandum identifying alternative solutions as a basis for a public hearing.
The June 24, 1974, Status Report indicated a change in the FASB’s position:

The Standards Board has dropped a previously an-nounced interim step in its project on accounting for business combinations and intangible assets and has decided, instead, to proceed directly with total reconsideration of two Accounting Principles Board Opinions on the subject.
The FASB felt that the project should extend beyond the mere consideration of the pooling criteria to encompass the underlying theory of business combinations.
On August 19,1976, the FASB Discussion Memorandum, “Accounting for Business Combinations and Purchased Intangibles,” was issued. It provided the basis for a public hearing scheduled to be held in New York on May 17, 1977.

In December 1976, the FASB announced that it would hold a public hearing in June 1977 on the conceptual framework for financial accounting and reporting. As a result, the public hearing on business combinations and purchased intangibles would be rescheduled [FASB Status Report, December 5, 1976]. This hearing was ultimately rescheduled for the second half of 1978, with an exposure draft and final Statement expected in 1979 [FASB Status Report, October 13, 1977 ].
The April 26, 1978, Status Report indicated that “the Board has received recommendations to postpone a public hearing and not to issue a Statement on that topic [Business Combinations and Purchased Intangibles] until it has substantially completed certain phases of the conceptual framework project. Additional information is being obtained as to the priority to be assigned to the business combinations project” [pp. 1-2]. The Board announced in October of 1978 that the planned timing for the business combinations project had been moved back, awaiting the issuance of a Statement of Financial Accounting Concepts on the Elements of Financial Statements of Business Enterprises. The public hearing on business combinations was not expected until the fourth quarter of 1979, with a final Statement not expected until 1981 [FASB Status Report, October 25, 1978].

As work on various of its projects progressed, the FASB concluded that “a Statement on elements and an updating supplement to the August 1976 [business combinations] discussion memorandum should precede a public hearing on this project. Accordingly, a public hearing is not expected before 1980” [FASB Status Report, July, 6, 1979]. In October of 1979, the Board announced that “the project is inactive pending further progress on the conceptual framework, especially elements of financial statements” [FASB Status Report, October 17, 1979]. After more than a year of inactivity, the FASB announced that the business combinations project had been removed from its agenda “because of low priority in relation to other existing and potential projects” [FASB Status Report, April 10, 1981].

Considering all of the concern with the inadequacies of APB Opinion No. 16 expressed by the public in response to the FASB’s 1973 open letter, it seems surprising that the FASB’s ultimate conclusion was that the business combinations project was one of “low priority.” However, from the time the Discussion Memorandum was issued in 1976 until 1981, only sixteen comment letters were received by the FASB [Letters of Comment on the Discussion Memorandum of the FASB]. An analysis of these comment letters is summarized in Exhibit 1.

Exhibit 1 Discussion Memorandum Comments
Number of Comments General Position
2 Preferred to defer consideration of the issue until the Conceptual Framework Project was completed
4 Did not specifically refer to poolings
6 Supported APB Opinion No. 16 (some with slight modifications)
2 Recommended elimination of poolings
1 Considered pooling preferable to purchase regardless of method of payment
1 An outline only

Most, if not all, of the positions taken in the comment letters were unsupported with logic or theory, and little effort was made to defend arguments. Clearly, the FASB received no mandate for major change in accounting for business combinations from these responses.

Hermanson and Hughes [1980] reported on a study of the satisfaction of accounting practitioners, accounting educators, and financial executives with APB Opinion No. 16 and No. 17. Their survey of 600 individuals suggested that “the major accounting groups seem to have learned to live with—and, in some cases, appreciate—Opinions 16 and 17.” Their message for the FASB was: “Take your time” [p. 15]. They discovered that educators and financial executives tended to differ in their opinions while accounting practitioners sided in some cases with educators and in other cases with the executives. Table 1 presents selected results of their findings concerning satisfaction with APB Opinion No. 16. Table 2 presents their findings concerning the appropriate treatment of goodwill [APB Opinion No. 17].

The FASB apparently was in agreement with Hermanson and Hughes since it has largely ignored the issue of business combinations in genera] (and poolings of interests specifically) following the abandonment of the business combinations project in 1981. The FASB issued Technical Bulletin No. 85-5 in June of 1985 entitled “Issues Relating to Business Combinations.” Regarding poolings, the technical bulletin addressed the issues of downstream mergers, identical common shares, and the combination of mutual and cooperative enterprises, all with reference to the application of APB Opinion No. 16. The SEC issued Staff Accounting Bulletin No. 65 in November of 1986 in which the SEC’s staff discussed its views on certain matters involved in the application of Accounting Series Release No. 130 and No. 135 regarding risk sharing in business combinations accounted for as poolings of interests. For the most part, however, the authoritative bodies have allowed the accounting for poolings of interests as provided for in APB Opinion No. 16 to stand.

In fact, APB Opinion No. 16 has only had paragraphs amended or superseded seven times, and none of those changed the criteria for accounting for a business combination as a pooling of interests. Additionally, the FASB has issued only four interpretations and two technical bulletins regarding APB Opinion No. 16. One of the interpretations, FASB Interpretation No. 21 [April 1978], and one of the technical bulletins, FASB Technical Bulletin No. 85-5 (see above), addressed pooling of interests. FASB Interpretation No. 21 clarified application of FASB Statement No. 13, “Accounting for Leases,” in a pooling as well as in a purchase combination.

The continuing acceptability of pooling of interests accounting has not silenced all critics, however. Dieter [1989], in considering the need for changes in accounting for business combinations, attacks the pooling concept.

Table 1 Degree of Satisfaction with APB Opinion No.
Very Very Number
Satis- Satis- Dissatis- Dissatis- of
fied fied Neutral fied fied Responses

The pooling criteria
Practitioners 5.5% 52.7% 18.2% 16.4% 7.2% 55
Educators 1.8% 28.1% 17.5% 40.4% 12.2% 114
Financial Executives 1.1% 52.5% 15.6% 20.0% 11.1% 90
The manner of
recording a pooling
Practitioners 7.3% 56.4% 21.8% 9.1% 5.4% 55
Educators .9% 38.2% 23.6% 26.4% 10.9% 110
Financial Executives 2.2% 64.8% 14.3% 11.0% 7.7% 91
The manner of
recording a purchase
Practitioners 12.7% 60.0% 14.5% 12.8% 0.0% 55
Educators 9.1% 64.5% 13.6% 12.8% 0.0% 110
Financial Executives 5.5% 68.1% 9.9% 11.0% 5.5% 91
Source: Hermanson, R. H., and H. P. Hughes. “Pooling vs. Purchase and Goodwill: A Long-standing Controversy Abates.” Mergers & Acquisitions (Fall, 1980): 17.
Table 2 Opinions Regarding Treatment of Goodwill
APB Opinion No. 17

Practi-tioners

Financial Educators Executives

63.6%
25.5% 10.9%
55
66.7%
23.7% 9.6%
114
63.3%
26.7% 10.0%
90
Goodwill should be: Recorded as an asset Immediately written off or shown as a reduction of stockholders’ equity Other
Number of responses If goodwill is capitalized as an asset, the subsequent treatment of it should be to:
1.8% 2.7% 6.8%
72.8% 69.6% 55.8%
12.7% 12.5% 22.7%
10.9% 2.7% 5.6%
0.0% 1.8%
55 2.7% 9.8%
112 1.1% 8.0%
88
Retain it permanently as is Amortize it mandatorily against current income Amortize it mandatorily directly to retained earnings Amortize it optionally against
current income Amortize it optionally directly to retained earnings Other Number of responses

Source: Hermanson, R. H., and H. P. Hughes. “Pooling vs. Purchase and Goodwill: A Long-standing Controversy Abates.” Mergers & Acquisitions. (Fall, 1980): 18.

The present rules, embodied primarily in APB Opinion Nos. 16 and 17 … were a convenient compromise, not rules of reason and logic … the concept of pooling-of-interests is an accountant-related concept that bears no relationship to economic reality and is at variance with the primary transaction-based approach used in most areas of accounting today. The conceptual arguments to support continuation of this form are weak. In almost all business combinations that are accounted for as poolings-of-interests, an economic event has taken place whereby one entity has acquired another. To not account for these very significant transactions at their economic value further erodes the credibility of continuing financial statements [p. 44].

Despite arguments such as these, the pooling method is still generally accepted. The criticisms have not been severe enough nor sufficient in number to move the authoritative bodies to action.

APB Opinion No. 16 celebrated its twentieth birthday in November of 1990. Except for interpretive pronouncements, the sections of the opinion related to pooling of interests have not been changed. The FASB has had a project on “Consolidations and Related Matters” on its agenda since January 1982. One part of this project is addressing when a new basis of accounting is appropriate. This part of the project is in the early stages of development with a Discussion Memorandum [FASB, September 10, 1991] recently issued. What impact, if any, these deliberations will have on accounting for a business combination as a pooling of interests cannot be predicted.

In its annual overview of the activities of the FASB, the Financial Accounting Standards Advisory Council [1990] surveyed current and former Council members, soliciting their views on the priorities and timetables of each of the FASB’s current agenda items. The respondents stated that “Business Combinations continues (as it did in the prior year) to be the first choice of Council members for a major new agenda project when the Board has the capacity to add one” [Financial Accounting Standards Advisory Council, 1990, p. 1]. Thus, there is some pressure for the FASB to revisit this issue. Until it does, APB Opinion No. 16 continues in force essentially unchanged as it relates to pooling of interests accounting for business combinations.

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