Back in the late 1990s, this column criticized those who supported pooling-of-interests accounting for business combinations. We called it "pfooling" because it was designed to trick the capital markets into believing false financial statements.Eventually, the Financial Accounting Standards Board did eliminate pooling, although it was unwilling or unable to do anything about the misleading information produced by past poolings through retroactive application. Those bad numbers will hang around for decades, making the affected statements much less useful.

With the apparent direction of the new Conceptual Framework, a new day is coming in which the guiding force will be the usefulness of reported information for anticipating future cash flows, not its preparation ease or its ability to make managers look good.

In October, FASB made a relatively quiet move to eliminate one last vestige of pfooling by proposing that it no longer be allowed for nonprofits. We were caught by surprise, because we didn't realize it was still alive. Obviously, we are pleased to see the wooden stake poised over its heart. However, as our readers know, we are seldom truly pleased with any standards (old or new) because they always fall short, even way short, of what could be done to improve market efficiency.

Further, our criticisms are not just at the margin, but are directed toward big shortcomings that, at least to us, seem obvious when we look at generally accepted accounting principles from the standpoint that financial reporting should go all out toward serving statement users' needs for information and society's need for users to be well informed.


The accompanying table (page 13) summarizes the permutations between book and market value that are possible in accounting for business combinations.

When combined statements are prepared under pooling, the old and obsolete book values for the seller's assets and liabilities are added to the old and obsolete book values for the buyer's assets and liabilities. While it is easy to do, the result can only be old and obsolete measures that are not useful for predicting future cash flows.

Under purchase accounting, new and up-to-date market values for the seller are added to old and obsolete book values for the buyer, producing a hopeless mishmash of new and old. Compare it with reverse-purchase accounting, where the old and obsolete book values for the seller are blended with the market values for the buyer.

What's that? You haven't heard of reverse-purchase accounting? Neither have we, until just now. What's our point? Simply that it makes no sense to add book and market values, regardless of which company is which. The consequence has to be statements that fall well short of useful.


The fourth possibility is what we call "real basis," and what others have called "new basis." Simply put, everybody's assets and liabilities are marked to market. Old book values are discarded as quickly and completely as losing lottery tickets. The result is balance sheet and income statement measures that reflect the real truth.

This is, of course, the direction that practice ought to be going. It also means that no one who wants useful financial statements should be satisfied with anything less. Purchase accounting is an improvement over pfooling, but not nearly as much of an improvement as going to the real basis.

It won't be surprising that we advocate that the next step in accounting for combinations should be to the real basis. By using market values for all assets and liabilities, management will provide statements that tell the truth in ways that users find useful. The market values are simply the best available and most representationally faithful depictions of the relevant information about the combined entity's future cash flow potential.

Despite this advantage, which we find to be inarguable, a great many will object, even vehemently, to the real basis. Those people will not see it as a serious contender for GAAP (or other widespread practice) and will roll out time-worn clichés that market values are too elusive, too subjective and too expensive to be put into financial statements. Besides, some will argue, market values are not relevant and have no place in the statements.

If so, they will be arguing without a solid footing and will look worse than pfoolish. Their points are specious and logically empty, as well as contradictory to practice.


If you look at the table again, the only difference between real basis accounting and purchase accounting, which practitioners now embrace, is that it measures the buyer's assets and liabilities with the same value measurement processes that are applied to the seller's assets and liabilities.

If the seller's market values are relevant, representationally faithful, verifiable, auditable, economically generated and otherwise useful, then the same must be true for the buyer's market values. To argue otherwise is, well, just not sound, because it ignores the fact that the results of real basis accounting will be no less relevant, representationally faithful, verifiable, auditable, economically generated and otherwise useful than the results of purchase accounting. So why not make the move to it?


Of course, one drawback is that most managers just don't want to report market values because that would mean surrendering control over information that users want.

They are, of course, quite mistaken in thinking that they can control their securities' market prices by withholding information that users need to make rational decisions. By providing incomplete information, they increase users' uncertainty and their risks, and the only appropriate response by those users is to bid security prices down, not up. Managers are cutting off their noses to spite their faces.

Another perceived disadvantage is that the practice of recognizing market values as of the combination date would break the decades-old logjam against reporting market values at every statement date, not just when major transactions occur.

This resistance cannot be legitimately justified by asserting that the measures cannot be produced - after all, they are routinely produced under GAAP for the seller's assets and liabilities for every combination. That same technology could be applied just as easily and accurately at every subsequent balance sheet date.


Some will say, "Bah! Don't these fuzzy-headed professors have a clue about how much it would cost to update the accounts all the time?"

Certainly we do, and we acknowledge that it would cost more. But the fact that something costs more doesn't mean that it shouldn't be pursued.

After all, how many of us rent or own a comfortable space, even though it costs more than living in a tent on the sidewalk? How many of us own a car, even though it costs more than walking miles to work? How many of us choose to eat, even though it costs more than not eating?

Our point is simple: You can't say that something costs more and conclude that it therefore costs too much. It costs too much only if it fails to produce benefits in excess of those costs. And that's where so many involved in standard-setting come up short all the time. They think only of preparation costs, without looking at the benefits gained by creating fully informed and efficient capital markets. The certain outcome for a management that provides better information will be higher security prices and lower capital costs. This benefit will greatly exceed the preparation costs.


We commend FASB for stamping out this last remnant of pfooling and for its ongoing project to freshen the purchase method. However, these efforts represent a few short steps down a long and arduous path. Society's information needs will not be met until all assets and liabilities are marked to market.

Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at

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