Accounting changes to affect network mergers

The standards body that sets U.S. accounting rules last week reaffirmed an earlier decision to eliminate the "pooling of interests" method of accounting favored by merger artists within the network and telecommunications industries. But the quasi governmental group also indicated it would modify alternative purchase accounting rules to allay industry concerns.

The Financial Accounting Standards Board (FASB) voted unanimously to eliminate the pooling method and set a deadline of late June, after which all business combinations must be accounted for using the purchase method. The seven-member FASB is independent but is authorized by the U.S. Securities and Exchange Commission (SEC).

FASB wants to standardize all business combinations on one accounting method, and it believes that the purchase method provides more detailed information to investors.

High-tech trade groups were pleased that the FASB was willing to rethink its position on purchase accounting rules, but they remain unhappy about the elimination of pooling. They fear that eliminating pooling could significantly reduce merger and acquisition activity, reduce the amount of capital available to start-ups and otherwise stifle innovation.

"We still think that pooling should remain," says Kim Boylan, a partner with Mayer, Brown & Platt and counsel for the lobbying group TechNet. "We think that abolishing pooling could have a negative affect on the economy."

Among the network vendors that regularly use pooling are Cisco Systems Inc., WorldCom Inc. and America Online Inc. Indeed, Cisco made 24 acquisitions in 2000, many using the pooling method.

"We see no need for any change to pooling accounting at this time," says Dennis Powell, a Cisco vice president. While Powell lauds the FASB's proposed changes to the purchase method, he says "it would be premature and counterproductive to make any changes in the pooling method of accounting" until outstanding issues related to purchase accounting are resolved.

The FASB first voted to eliminate the pooling method 16 months ago, setting off a firestorm of lobbying activity by high-technology trade groups and venture capitalists trying to reverse the decision. The FASB has the authority to set accounting standards in the U.S. The SEC can reverse its decisions though it rarely does.

Proponents of pooling still hope to retain this 50-year-old method of accounting, which is used for the majority of U.S. corporate mergers. But at a minimum they are seeking changes to the purchase accounting rules to better reflect the realities of today's economy, where most of a company's value is in intangible assets such as people, intellectual property and brand names rather than in factories or inventories. Specifically, they want to eliminate the purchase accounting requirement that a company amortize -- or take a charge against earnings -- for its intangible assets over a pre-determined length of time.

Congress got involved in the accounting debate last spring, holding hearings to gauge the impact on the economy if the pooling method were to go away. By fall, when it looked as though the FASB would not reconsider its position, two California congressmen introduced legislation that directed the SEC to set a moratorium on any FASB decision to eliminate pooling until a study could be done on its economic impact.

The logjam started to break in December, when the FASB made a tentative decision to change the purchase accounting rules for goodwill, or intangible assets. Instead of being automatically amortized, goodwill would be reviewed for impairment, that is, written down and expensed against earnings only when it declined in value.

This new approach to goodwill, which the FASB reaffirmed last week, is viewed as a possible compromise by many in the high-technology community, which is cautiously optimistic about the FASB's direction.

"We're not out of the woods yet, but we're very encouraged by the FASB's recent announcements about their change in attitude toward amortizing goodwill," says Paul Brownell, vice president for public policy at the National Venture Capital Association (NVCA). "However, there are still some questions remaining with their impairment proposal."

"The FASB's plan for an impairment test that would assess the real-world value of goodwill would enable companies' financial statements to more clearly reflect economic reality," Cisco's Powell says. "We are pleased the FASB is moving in this direction."

Many details of the FASB's goodwill impairment test still need to be worked out, including how frequently it must be done. High-technology companies prefer the expensive and time-consuming impairment test be done only when a triggering event occurs, rather than every year.

Another outstanding issue is how the FASB will handle intangible assets that are hard to separate from a company's overall business plan.

"If the FASB doesn't try to argue that all intangibles can be separated out and uniquely valued, I think they will make tremendous progress," says Barry Rogstead, president of the American Business Conference, which has lobbied against the elimination of pooling. "If the FASB makes purchase accounting sufficiently attractive, then businesses won't miss pooling."

How much of an impact the elimination of pooling and the revamping of purchase accounting will have on the network industry remains unclear.

"It's a little early for the high-tech community to make an evaluation because [the FASB] is not through with this process yet," says Caroline Graves Hurley, tax counsel and director of tax policy for the AeA, a high-technology trade group. "They've talked more conceptually than specifically. They have to expose their thoughts, and we are waiting to see what they look like."

The next step in this process is for the FASB to release details about its goodwill impairment proposal, which are due in mid-February. Interested parties will have a month to comment, with a final statement due from the FASB in late June.

And the fight over pooling isn't over yet. The issue remains a top priority for the NVCA, TechNet and other lobbying groups.

TechNet's Boylan points out that European and Asian countries allow pooling, although its use is more limited outside the U.S.

"None of our major competitors has prohibited pooling in all circumstances," she says. "We have the best technology development and the best capital markets in the world. Things are working here. Why do we want to monkey with that?"

This story, "Accounting changes to affect network mergers" was originally published by Network World.

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