584 Making Key Strategic Decisions
expense for book purposes over a period of not more than 40 years. The amor-
tization of purchased goodwill is deductible for tax purposes and is taken over
15 years.
Under the pooling of interests method,the assets of the two firms are
combined, or pooled, at their historic book values. There is no revaluation of
assets to ref lect market value and there is no creation of goodwill. Because of
this, there is no reduction in net income due to goodwill amortization. This
method requires that the acquired firm’s shareholders maintain an equity
stake in the surviving company and is therefore used primarily in acquisitions
for stock.
Weston and Johnson report that 52% of the 364 acquisitions they analyzed
used pooling and 48% used purchase accounting.^16 To illustrate the difference
between the two methods of accounting for an acquisition, we offer a simple
example.
Example 7 Consider the following predeal balance sheets for B.B. Lean Inc.
and Dead End Inc., both clothing retailers:
B.B. Lean Inc. ($ millions) Dead End Inc. ($ millions)
Cash $ 6 Equity $28 Cash $ 3 Equity $12
Land 22 Land 0
Building 0 Building 9
Total $28 $28 Total $12 $12Now assume that B.B. Lean offers to purchase Dead End for $18 million
worth of its stock and elects to use the purchase method of accounting. As-
sume further that Dead End’s building has appreciated and has a current mar-
ket value of $12 million. B.B. Lean’s balance sheet after the deal appears as
follows:
B.B. Lean Inc. ($ millions)
Purchase Method
Cash $ 9 Equity $46
Land 22
Building 12
Goodwill 3
Total $46 $46Note that the acquired building has been written up to ref lect its market
value of $12 million and that the difference between the acquisition price ($18
million) and the market value of the assets acquired ($15 million) is booked as
goodwill. Lean’s equity has increased by the $18 million of new shares it issued
to pay for the deal.
Now assume that the same transaction occurs, this time using the pooling
method.