Pooling of interests: Overview, definition, and example
What is pooling of interests?
Pooling of interests is an accounting method used to combine two companies into one without recognizing any goodwill or other intangible assets. Under this method, the financial statements of the two companies are combined as if they had always been one company. There is no adjustment for the fair value of the assets, and no goodwill is created. The pooling of interests method was primarily used in business mergers and acquisitions before being largely replaced by the purchase method under current accounting standards.
For example, if two companies merge and decide to use the pooling of interests method, their balance sheets would be combined without adjusting the values of their assets or recognizing any goodwill.
Why is pooling of interests important?
Pooling of interests was important because it allowed for a more straightforward and simpler accounting process when merging two companies. It treated the merger as a combination of equals, which could make the merger appear less financially complex. By avoiding the recognition of goodwill, companies could avoid inflating the value of the merged entity. However, due to concerns over transparency and the potential for misuse, the pooling of interests method was phased out in favor of the purchase method, which requires companies to record the fair value of assets and liabilities.
For businesses, understanding the concept of pooling of interests is essential for historical context, especially if they are involved in mergers or acquisitions where this method was previously used.
Understanding pooling of interests through an example
Imagine two companies, Company A and Company B, decide to merge and use the pooling of interests method. They combine their financial statements, and the assets and liabilities from both companies are added together without adjusting for their market value. If Company A has assets valued at $1 million and Company B has assets valued at $500,000, the combined entity would report assets totaling $1.5 million, but there would be no recognition of any goodwill or adjustments to the fair value of the assets.
In another example, two small businesses merge to create a larger company, and they agree to use pooling of interests for the merger. Both businesses contribute their assets and liabilities equally, and the combined financial statement shows the sum of the two businesses’ values, but no new intangible assets are recognized.
An example of a pooling of interests clause
Here’s how a clause involving pooling of interests might appear in a contract:
“In the event of a merger between the Parties, the transaction shall be accounted for using the pooling of interests method, where the financial statements of the Parties shall be combined without recognizing any goodwill or adjustments to the fair value of the assets.”
Conclusion
Pooling of interests was a method used to account for mergers and acquisitions where the companies combined their assets and liabilities without recognizing goodwill or intangible assets. While it was useful for simplifying accounting, it was eventually replaced by the purchase method to improve transparency and accuracy in financial reporting. For businesses involved in historical mergers, understanding the pooling of interests is essential to fully grasp the financial structure of those transactions.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.