Question

1. Why might pooling of interest be considered fraud?

2. What impact does it have on earnings?

3. Why was this only abusive in the acquisition of private companies?

Answer 1

1. The pooling of interest method might be considered fraud because, under this method, assets and liabilities are considered at book value instead of fair market values so no goodwill is reported in connection with the acquisition or merger. Hence it does not truly representative of the exchange in value in a business combination.

2. As the pooling-of-interests method did not include goodwill, the price above the fair value price and because no write-downs for goodwill were required under the method. This had the additional benefit of increasing returns on assets and equity. which therefore had a strong and positive impact on earnings.

3. Private companies try to adopt the shortest route to show higher market capital through acquisitions or buying other companies without showing goodwill in the books as their image is based on their market capitalization as well as private companies are able to avoid recording the related acquisition costs.

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