Chapter 8 Discussion Question #3, #5, and #11
3.
The purchase method is used when one entity acquires another, whereas the pooling method accounts for the uniting of the ownership interests of two (or more) entities. The pooling-of-interest method provides distinct advantages to many firms entering into a business combination. The assets and liabilities of both parties are combined at book value and revenues and expenses are combined retroactively. With the purchase method, the assets and liabilities of the acquired firm are adjusted to fair value; its reacquisition revenues and expenses are excluded from the combined income statement .In effect, the acquiree's books as of the date of the business combination are treated as if it were the end of its fiscal year, even though it may not be .For pooling accounting, however, the combinee's results of operations prior to the date of acquisition are included in the combiner’s results of operations as if the combination took place at the beginning of the year. The future earnings of pooling companies tend to be higher than those of purchase companies, primarily because of additional depreciation and goodwill amortization. Because of the possibility of abuse, the APB placed tight restrictions on the use of the pooling method by requiring compliance with twelve criteria. Perhaps the most important (and difficult) of these requires that a company exchange a portion of its shares for at least 90 percent of the voting stock of the other company. If any of the twelve criteria are not met, the business combination must be accounted for as a purchase. It is believed that under purchase accounting , the investment by the holding company contributes to group profits only after the combination whereas under the pooling-of-interests method , all the pre-combination profits are