Purchase versus Pooling in Stock-for-Stock Acquisitions: Why Do Firms Care?

The accounting for business combinations has long been one of the most controversial financial reporting issues, generating numerous opinions and interpretations by the American Institute of Certified Public Accountants (AICPA), Financial Accounting Standard Board (FASB), Securities and Exchange Commission (SEC) and the Emerging Issues Task Force (EITF). At the center of the controversy is the principal established in 1970 by Accounting Principles Board Opinion (APBO) No.16 that both the purchase method and the pooling-of-interests method are acceptable in accounting for business combinations. The distinction between purchase and pooling relates mainly to how the difference between the price paid for the common shares of the acquired company and the book value of its net assets (herein referred to as the "step-up") is accounted for on the consolidated financial statements. Under the pooling method, the step-up is not recognized and the net assets of the acquired company are combined with those of the acquiring company at their book values as though the two companies had always been a single enterprise. Under the purchase method, the acquiring company recognizes the differential by restating all assets and liabilities of the acquired company to their fair values. Consequently, the additional depreciation and amortization expense arising from the asset write-up often associated with the purchase method leads to post-merger earnings that can be substantially lower than those reported under the pooling treatment.