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DRAINED OF "POOLING OF INTERESTS" ACCOUNTING, COMPANIES MAKING ACQUISITIONS MUST VALUE INTANGIBLE ASSETS.
STOCK PRICES ARE RISING, BUT CASH IS STILL KING. Cash is real. It's tangible. You need it to pay people who provide your company with labor, supplies, or services. But earnings, an intangible form of income derived from uniform accounting rules, still drive stock prices. That's the bottom line. And managers typically will lunge for ways to boost it.
One way to pump up earnings is to merge with another company. By merging with another firm under the popular "pooling of interests" method of accounting, a company can make its earnings look abnormally large. It can also make financial measurements based on accounting numbers, such as return on equity, look a bit spiffier.
This accounting sleight of hand, along with ever-rising stock prices and, of course, economics of product markets, have coalesced recently to justify a majority of recent mergers, both to the markets and among managers doing the deals.
But the accounting incentive of these mergers is slated to be scrapped by year-end. The Financial Accounting Standards Board (FASB) issued a proposal last September to abolish pooling of interests. It wants companies to use the purchase method of accounting for business combinations.
POOLING MAGIC
This isn't welcome news, particularly among companies who are enjoying the magic of pooling. Firms who like pooling most are those with a lot of intangible assets-intellectual property, brand names, copyrights, patents, customer lists, research and development.
Under pooling of interests, the merged entities merely combine the book value of their tangible and intangible assets at their original cost-that's if the assets have an original cost. Many intangibles don't, and their post-merger value remains zero.
That means an acquirer can report what was earned from the intangible assets it bought, but it doesn't have to amortize, or deduct from income, any of its cost. That helps doubly enhance earnings. Also, many assets that do have a book value under pooling have a depreciable life of up to 40 years. In other words, firms can deduct from income annually the dollar amount of what was "used up" for each asset each year for as long as 40 years. That, too, bolsters earnings.
And in today's growing information...