For-profit healthcare consolidations might be slowed if the nation's arbiter of accounting standards eliminates or restricts "pooling-of-interest" combinations.
That's one possible outcome of the Financial Accounting Standards Board's review of criteria used to account for business combinations. The FASB plans to issue a special report this week describing the scope of its review and seeking suggestions on what direction it should take. Comments are due by Sept. 1.
If the FASB were to curb or scrap poolings, "it would certainly make all the acquiring companies look more carefully at (a deal's) impact on their earnings per share going forward," says W. Brent Kulman, a managing director of corporate finance at Interstate/Johnson Lane Corp., a Charlotte, N.C.-based investment banking firm.
The FASB, based in Norwalk, Conn., is the private, independent body responsible for establishing and interpreting generally accepted accounting principles, or GAAP. Urged by the Securities and Exchange Commission to take up the issue, the FASB intends to rethink what constitutes a business combination and when pooling-of-interest and purchasing accounting methods should be applied.
Restricting or eliminating poolings is "a possible outcome," confirms Todd Johnson, a senior project manager at the FASB.
Under GAAP, companies can record consolidations two ways: through the purchase method of accounting or through a pooling. The methods produce radically different accounting results. Pooling allows companies to avoid big hits to future earnings. Purchase accounting does not (See charts).
"If the methods didn't produce such pronounced (differences)," the issue wouldn't be drawing so much attention, Johnson says.
Those differences may be provoking some accounting mischief. "There certainly have been assertions that some companies are stretching the limits to achieve pooling treatment," Johnson acknowledges.
Poolings, which allow companies to combine assets and liabilities through a stock swap, have come under fire as the volume of business combinations in all industries has swelled.
Healthcare is among the most active industries on the consolidation bandwagon. New Canaan, Conn.-based Irving Levin Associates tracked 234 healthcare mergers and acquisitions in the fourth quarter of 1996, which was the third-largest number of deals in the 14 quarters tracked by Levin.
Many companies prefer the pooling method because it avoids the need to record goodwill, which can dilute earnings. When pooling assets, the buyer simply books the combined assets.
Under the purchase method, a company records the acquired organization's assets at fair market value. Any goodwill-the premium paid over the value of the assets-must be amortized, or written off, against future earnings, over as many as 40 years. Goodwill can include the value of trademarks and patents.
Poolings are especially popular among for-profit companies involved in large consolidations valued at $100 million or more, Johnson says. When Columbia/HCA Healthcare Corp. merged with Healthtrust in 1995, for example, the deal was booked as a pooling of interests.
However, when one company uses the purchase method and another uses pooling, it becomes difficult for investors to make comparisons.
The FASB hopes to clarify when a business combination can be recorded as a pooling. Documents describing the criteria for a pooling require a burdensome amount of interpretation. Those documents were inherited by the FASB in 1973 from the now-defunct Accounting Principles Board.
"They continue to generate a large volume of questions for the SEC staff and for our staff," Johnson says.
To qualify for a pooling, companies must meet 12 stringent criteria, which are constantly being updated for clarification. Poolings are still getting done, says John Bigalke, partner in charge of Price Waterhouse's East region managed-care practice, but it's tougher to meet the criteria. "The general tone of the marketplace in general and the SEC in particular is that it's getting harder and harder to do," he says.
The FASB also may seek to eliminate or restrict poolings to achieve international comparability. As the capital markets become more global, there is a gradual push to bring U.S. accounting standards in line with the rest of the world, Johnson explains. "Poolings are fairly rare in many other countries," he says.