Finance Subcommittee Hearing on
FASB Exposure Draft on Accounting For Business
Combinations--Should Pooling Be Eliminated?

May 4, 2000

Mr. Chairman, I thank you for holding this hearing.

There is probably no stronger defender of the Financial Accounting Standards Board or FASB and the independent setting of accounting standards than I have been over the length of my Congressional career. I say this even though I don’t agree with every last detail of every accounting standard that FASB has ever set. Making us happy is not their task. Their job is to promulgate accounting standards of high quality that do not favor any particular industry or interest group and that maintain the credibility of our financial reporting system. The unparalleled success of the U.S. capital markets are due in no small part to the high quality of the financial reporting and accounting standards promulgated by FASB.

If I have any criticism of FASB, and I do, it’s that they have a political tin ear and make a lot of powerful enemies. But their decision-making process is supposed to be neutral and thorough and open and informed, and it is all that. They have a tough job to do. I respect that and I welcome them here today as I do all of our witnesses.

On the substance of today’s hearing, I have not made up my mind what the right answer is. I am not an accounting expert. I think both sides have good points that need to be addressed.

The 1970 "compromise" by the Accounting Principles Board to allow both purchase and pooling accounting for business combinations was highly controversial, strongly dissented from, and showed serious fault lines during the merger boom of the 1980's.

After several years of deliberation and debate at the urging of affected parties, FASB has issued an exposure draft that proposes replacing the pooling of interests method with the purchase method for almost all business combinations. Currently, companies can use pooling if they meet 12 criteria.

Under the purchase method, an acquiring company records the value of an acquired company at the cost it actually paid. Under pooling of interests, the combining companies simply add together the book values of their assets, leaving investors with no way to determine what price was actually paid or tracking the acquisition’s subsequent performance. In an example sited at page 5 of FASB’s prepared remarks, involving a $10 billion transaction that was accounted for under the pooling method, the book value of the company being acquired was only $500 million. The acquisition, therefore, was reported at $500 million in the financial statements of the combined company, and $9.5 billion of value simply disappeared. Where did it go?

Despite no real change in cash flows, the pooling method also creates a false image of increased earnings, say its critics. Dramatically different results are produced by the two accounting methods, making it difficult for investors to compare companies. This also creates competitive disadvantages.

High-tech companies and financial institutions oppose the FASB proposal saying that if pooling is eliminated or curtailed it will destroy their industries, the M&A market, the stock market and the U.S. economy. Other companies, such as General Motors, whose chief accounting officer will testify today, the respected rating agency Moody’s Investors Service, the Council of Institutional Investors, the Consumer Federation of America, and other groups representing investors and consumers support the FASB proposal.

A May 1999 study by Goldman Sachs concluded that the proposed accounting changes will not have a material adverse effect on future business consolidations, although the study did identify some industries that may be adversely affected. I ask unanimous consent that the study be included in the record.

I also understand that most foreign countries prohibit pooling or allow it only as an exception. For example, the United Kingdom and the International Accounting Standards Committee permit pooling only when both companies are of the same size or the acquiring entity cannot be identified. Canada is considering a proposed standard much like FASB’s. As the managing director, corporate finance at Moody’s noted in his comment letter to FASB: "Moody’s supports the objectives of accounting standards setters to improve the harmonization of accounting standards globally, and welcomes FASB’s proposal to eliminate the pooling of interests method. We believe that a single method can improve analytic efficiency, especially in cases where a single transaction or essentially identical transactions would produce dramatically different accounting results, and thus enhance the ability of cross border capital market participants to compare, easily and accurately, alternative investments."