pooling for the purposes of the reconciliation to U.S. GAAP even though it may fail
the U.S. pooling rules. The SEC’s expectation when making this rule was that a pool-
ing under IAS 22 would be extremely rare because of the size test. In theory, the pur-
chase method is favored because it gives accounting recognition to the values trans-
acted in the business combination, which is considered to be relevant to investors and
creditors and appropriate in a transaction-based historical cost model. Enterprises,
however, generally prefer to use pooling accounting whenever possible because it
avoids the earnings drag associated with the depreciation and amortization of the fair-
value write-up, including goodwill, in future periods.
Now the stage is set for another international accounting controversy and debate.
The controversy unfolds because the IAS 22 criteria are not being uniformly inter-
preted in the restrictive way that the SEC staff had expected. The key issues in the
debate are as follows: (1) IAS 22 does not provide quantitative guidance on what is
meant by a “significant difference in size”; (2) IAS 22’s size test is actually contained
in a discussion paragraph of IAS 22 instead of a black letter standard, so its authori-
tative standing is unclear; (3) the relevance of the size test is questionable in stock-
for-stock transactions in which the pooling concept is otherwise satisfied (i.e.,
notwithstanding its relevance when a grocery store purports to merge with a super-
market chain); (4) FRS 6 provides that a party should be presumed to dominate if it
is more than 50% larger than another as judged by reference to ownership interests;
(5) FRS 6 explicitly states that the size test can be rebutted on the basis of specific
facts and under certain circumstances; (6) FRS 6 indicates that it is consistent with
IAS 22; and (7) the size test has no history in the United States, where big compa-
nies have historically managed to swallow up small companies without violating the
U.S. pooling rules.
As a practical matter, the SEC staff interpret similar size to mean virtually the
same size or that the fair value of each entity is approximately 50% of the combined
enterprise. In contrast, the Ontario Securities Commission in Canada has indicated
that under Canadian GAAP it would be extremely difficult for pooling to occur if one
entity was more than 55% of the combined enterprise, which would imply that one
party may be approximately 22% larger than the other. Under U.K. GAAP, one party
may be 50% larger than the other as noted above. This divergence is of great concern
to standard setters and regulators. A former chief accountant of the SEC, Michael H.
Sutton, addressed the subject of IAS 22 at the annual American Institute of Certified
Public Accountants (AICPA) SEC conference in February 1996, when he noted that
the SEC staff has addressed several proposals by non-U.S. registrants that in the
staff’s view were clearly inconsistent with the explicit requirements, as well as the
spirit, of the standard. He also indicated that the staff will insist that the core inter-
national standards be applied “rigorously”:
By that we mean that the standards, though they may be different than U.S. standards,
should be applied with the same degree of adherence to the spirit and intent of the stan-
dard that we now expect of U.S. registrants applying U.S. standards.Although the SEC is perceived as rule driven, it is clear that the Chief Accountant
couched his concern as being with the application of the “spirit” of non-U.S. stan-
dards. In fact the SEC staff has not accepted any business combinations as qualify-
ing for pooling accounting under IAS 22 and one may question whether the elimina-
tion of unitings of interests was the IASC’s intention when they drafted IAS 22. More
12.6 FINANCIAL STATEMENT EFFECTS 12 • 21