What it means
In a pooling, neither company was treated as the buyer. Assets, liabilities and equity were added line by line at their carrying values (the amounts already recorded in the books).
Earnings for earlier years were also restated to show the two businesses combined, so the merged company looked as if it had always existed. Companies liked this method because it did not require revaluing assets or recording goodwill, which is the premium paid above the fair value of the acquired net assets.
Without goodwill there was nothing to write off later, so future earnings were not reduced by amortisation (spreading a cost over time) or impairment charges. The reported results often looked smoother and stronger.
The cost was transparency. Investors could not see how much was paid for the target, and the deal's real price was hidden behind the old book values.
Two similar mergers could produce very different financial statements depending on which method was used, which made comparisons difficult. For these reasons, standard setters moved away from pooling.
Accounting rules now generally require the acquisition method, where the buyer records the acquired assets and liabilities at fair value and recognises goodwill for any excess price. Pooling of interests is mostly of historical interest, though you may meet it in older accounts and finance textbooks.
It remains useful for understanding how accounting choices can change what a merger looks like. A deal that creates $10,000,000 of goodwill under the acquisition method creates none under pooling, even though the economics are the same.
That lesson applies whenever managers can choose between accounting methods. Some mergers of entities under common control, where the same owners are on both sides, still use a similar approach of carrying over book values.
The key difference is that in those cases there is no independent buyer, so the rationale for fair value is weaker.
In practice
Real-world examples.
Example
Two regional banks of similar size merged in an old transaction and simply added their balance sheets together. The merged bank reported no goodwill and showed past results as a combined history. Shareholders in both banks became shareholders in the merged one.
Example
An analyst comparing two historic mergers finds one reported as a pooling and one as a purchase. To compare them fairly, the analyst has to rebuild the pooled deal's figures using fair values. Only then do the two deals' returns and balance sheets become comparable.
Example
A student studying accounting history builds a model showing the same merger under both methods. The difference in reported profit, caused by the absence of goodwill write-offs, helps explain why the rules changed. The student concludes that the acquisition method gives readers a better view of what was paid.
Formula
Calculation
Combined equity under pooling = equity of Company A + equity of Company B
Suppose Company A has assets of $80,000,000 and liabilities of $50,000,000, and Company B has assets of $40,000,000 and liabilities of $25,000,000.
Equity of A = 80,000,000 - 50,000,000 = $30,000,000.
Equity of B = 40,000,000 - 25,000,000 = $15,000,000.
Combined assets = 80,000,000 + 40,000,000 = $120,000,000.
Combined liabilities = 50,000,000 + 25,000,000 = $75,000,000.
Combined equity = 120,000,000 - 75,000,000 = $45,000,000, which equals 30,000,000 + 15,000,000, with no goodwill, because the books are simply added together.
Under the acquisition method, if A issued shares worth $30,000,000 for B, whose assets less liabilities are worth $20,000,000 at fair value, goodwill = 30,000,000 - 20,000,000 = $10,000,000.Case study
Seen in the real world.
Northwind Foods and Southgate Dairies are fictional companies that merge in an illustrative historical scenario. Northwind has equity of $30,000,000, and Southgate has $15,000,000. Under pooling the new group simply reports equity of $45,000,000 and profits that combine both companies' past results.
An analyst reading the group's accounts notes that Northwind issued shares worth $30,000,000 to buy Southgate, whose net assets at fair value were $20,000,000. Under an acquisition method, the extra $10,000,000 would appear as goodwill.
The analyst adjusts the group's figures to show the goodwill and the later impairment risk. The adjusted view gives a more honest picture of what the deal cost and what return the shareholders should expect, and the analyst's note to clients explains each adjustment step by step.
Watch out
Common mistakes.
- Thinking pooling is still a free choice today. Modern standards generally require the acquisition method for business combinations.
- Assuming no goodwill means no premium was paid. The price was simply not shown in the accounts, so a reader had to dig into the merger terms to find out what the shareholders actually gave up.
- Confusing pooling of interests with pooled funds. One is a merger accounting method, and the other is an investment structure.
Questions
People also ask.
Why did companies like pooling?
It avoided goodwill and its later write-downs, so reported earnings looked higher.
Why was it abolished?
Standard setters felt it hid the real price paid and made mergers hard to compare.
Is there a modern equivalent?
Combinations of businesses under common control can use carry-over values, which resembles pooling in some respects.
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