Pooling of Interests
Process of accounting where the assets and liabilities or balance sheets of two companies are combined at their historical cost during an acquisition or merger.
What Is Pooling of Interests?
Pooling of Interests refers to the process of accounting where the assets and liabilities or balance sheets of two companies are combined at their historical cost during an acquisition or merger.
Intangible assets are not included in the Pooling of Interests. When combining the balance sheets, the assets and liabilities are incorporated in each category and entered into the financial statements after making relevant adjustments.
The intangible assets are included only when recognized in the financial statements of either of the firms. Similarly, the firms' comprehensive income statements will include any expenses incurred during amalgamation.
It is essential to combine the separate financial statements of pooled companies to form a single set of messages. On the effective date of the pooling of interests, all the financial data of different companies should be available on a combined basis to ensure comparability.
Financial statements for at least a year before the effective date and the current year must be combined in the Pooling of Interests.
Key Takeaways
- Pooling of Interests is an accounting method used in mergers, combining assets and liabilities at historical values. Intangible assets are excluded, and adjustments are made before incorporating them into financial statements.
- This method benefits mergers, particularly in the technology sector, aiding in technology-related benefits, increased market presence, and avoiding acquisition costs.
- It contributes to inflated accounting ratios like ROE and ROA, offering simplicity in recording merged company finances.
- Pooling of Interests combines assets and liabilities at historical values in mergers, while Purchase Price records them at fair market value during acquisitions.
- Differences exist in recording, purchase consideration adjustments, treatment of intangible assets, handling accounts, accuracy of sales figures accuracy, and impact on ROA/ROE and reserves.
Advantages of the Pooling of Interests Method
This method has certain advantages in a merger between two companies. These advantages include the benefits related to technology, increased market presence, goodwill, and so on, but not limited to just these.
This simple technique makes the company's earnings appear higher than the actual figures and contributes towards inflated accounting ratios. Various technology firms also use it to avoid acquisition costs.
Some of the advantages include:
- Technology Sector: The method is extensively used in the technology sector. It is generally used to avoid recording any expenses arising from the acquisition of companies.
- Goodwill: Under this method, excess or deficit of purchase consideration over share capital is not reflected as goodwill. As a result, no write-downs for goodwill make the company's earnings look stronger.
- Accounting Ratios: The mathematical representation of the company's solvency, liquidity, and profitability is based on its financial statements. This method helps improve financial ratios such as Return on Equity (ROE) and Return on Assets (ROA).
- Simplicity: This method is simple and less burdensome because assets and liabilities of the merged company are recorded, which needs one set of books to be maintained for both income and expenses.
Disadvantages of the Pooling of Interests Method
The drawbacks of using this method make it less valuable. Due to these limitations, the Pooling of interests was later replaced by the Purchase Price method. The use of this method was limited because of factors such as incomplete information provided, exclusion of goodwill, & loss of comparability and realism.
Listed below are some disadvantages:
- It paints a not-so-realistic picture: The method records assets and liabilities at book values, failing to accurately represent a company's financial position, which undermines its realism.
- Lack of Comparability: It becomes difficult to compare the financial statements of two companies that have undergone a merger because different methods yield disparate results, complicating the assessment of financial performance.
- Goodwill Exclusion: Under the Pooling of Interests method, goodwill is excluded from the books of accounts. However, this exclusion aims to understand better tangible versus intangible assets and facilitate the assessment of the company's profitability, as perceived by the FASB.
- Information: This method must provide complete information to investors and other users of financial statements. Without adequate information, stakeholders struggle to determine the actual cost of one company acquiring another.
Pooling of Interests vs. Purchase Price Method
Pooling of Interest is a method of amalgamation where the assets and liabilities of the companies undergoing merger are recorded in the books of accounts. The values of the companies are summed and registered as a single figure.
It doesn't consider intangible assets; moreover, all the figures are documented at their book's value. The excess or deficit of the purchase amount over net assets is recorded as reserves.
Purchase Price is an accounting method in which assets and liabilities of the acquired company are recorded at fair market value in the acquirer's books at the time of acquisition. It considers all the help and liabilities, including tangible and intangible assets, at market price.
The excess amount paid by the acquirer over the net value of the assets and liabilities of the target company is recorded as goodwill in the acquirer's balance sheet, which gets amortized yearly.
The assets and liabilities of the acquired firm are added to the acquirer's balance sheet at fair market value.
| Basis | Pooling of Interests | Purchase Price Method |
|---|---|---|
| Definition | It is an accounting method in which assets and liabilities are summed and shown in the book or historical values on the date of amalgamation. | It is an accounting method in which assets and liabilities of the acquired company are shown at fair market value in the acquirer's books on the date of amalgamation. |
| Applicable | It is applicable in a merger, i.e., when a company merges with another to form one company. | It applies in the event of an acquisition, i.e., when a company acquires another company. |
| Recording | All the assets and liabilities are recorded at book values. | All the assets and liabilities are recorded at market values. |
| Purchase Consideration | Surplus or Deficit of Purchase Consideration over Share Capital is adjusted to Reserves. | Surplus or Deficit of Purchase Consideration over Net Assets acquired is adjusted by crediting or debiting Capital Reserves or Goodwill. |
| Intangible Assets | Intangible Assets such as goodwill are not recorded in the Pooling of Interest. | Intangible Assets such as goodwill are recorded in the Purchase method. |
| Accounts | Accounts of the companies undergoing merger are combined. | The acquirer takes over accounts of the acquired company. |
| Sales | Sales figures are accurate. | Sales figures are less accurate. |
| ROA/ROE | Both Return on Assets and Return on Equity are higher. | Both Return on Assets and Return on Equity are lower. |
| Reserves | The identity of the target company's reserves is kept intact. | The identity of the target company's reserves is not kept intact. |
Conclusion
Pooling of Interest was earlier used as an excellent technique for accounting assets and liabilities. It was extensively used in the technology sector because the method evaluated all the assets at book value.
It should have accounted for the changes in such valuable assets' historical or book values. Recording assets and liabilities at book values can potentially distort financial ratios and mislead internal and external stakeholders.
It is a simple method that helps improve the company's financial ratios. It records assets and liabilities at historical values, impacting certain financial metrics, which can, in turn, affect the appearance of earnings in the financial statements.
But now, this method has been replaced by the Purchase Price Method. It is suitable for showing accurate figures of assets and liabilities at their fair market values.
Under the Pooling of Interest method, the assets and liabilities of the acquired company are combined into the acquiring company's financial statements. It also takes into account intangible assets. The acquirer takes over reports of the acquired company by pooling method.
Pooling of Interests FAQs
The Pooling of Interest method is used when businesses are combined in a merger. This method records assets and liabilities at their historical values on the date of amalgamation.
The pooling method of accounting is eliminated and replaced by the purchase price method to enhance the quality of information provided to internal and external users of financial statements, such as investors, creditors, management, customers, tax authorities, etc.
If inventory amounting to $1 million consists of clothes that are no longer fashionable or in trend, the inventory may only be worth $300,000. However, the pooling method records the inventory at its historical value, not book value.
The inventory would be valued at a market price of $300,000 under the purchase method, which considers assets at their fair market value.
The Purchase Price method of accounting is used when the amalgamation is like a purchase, i.e., one business is acquiring another. This method considers the assets and liabilities at their market price.
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