APB 16: Former Rules for Business Combinations

Introduction

Accounting Principles Board (APB) Opinion No. 16, “Business Combinations,” served as the primary U.S. Generally Accepted Accounting Principles (GAAP) for corporate mergers and acquisitions for over three decades. Issued in 1970, it provided the framework for how one company would account for the takeover of another. The opinion governed these transactions until it was superseded in the early 2000s. Its historical importance lies in its attempt to bring structure to a complex area of accounting by establishing specific rules where practice had previously varied.

The Pooling of Interests Method

The pooling of interests method was founded on the concept that a business combination was a uniting of two separate ownership groups into a single entity. This approach viewed the transaction not as an acquisition but as a merger of equals. Consequently, the accounting treatment avoided recognizing new values for assets and liabilities. The balance sheets of the two companies were combined, carrying forward the existing book values from each entity and maintaining the historical cost basis.

To qualify for this treatment, a business combination had to satisfy twelve specific and restrictive conditions. These criteria were designed to ensure the transaction was truly a fusion of ownership interests and included the following:

• Each of the combining companies had to be autonomous and not have been a subsidiary or division of another corporation within two years before the plan of combination was initiated.
• The combination had to be effected in a single transaction or completed in accordance with a specific plan within one year.
• It could only involve the issuance of common stock in exchange for at least 90 percent of the voting common stock of the other company.
• The combined corporation could not agree to retire or reacquire any of the common stock issued to effect the combination.
• The combined company could not intend to dispose of a significant part of the assets of the combining companies within two years of the combination, except for disposals in the ordinary course of business.

These stringent requirements made qualifying for pooling of interests accounting a high hurdle.

The Purchase Method

When a business combination did not meet all twelve criteria for the pooling of interests method, it was required to be accounted for as a purchase. This method treated the transaction from the perspective of one company acquiring another. The process began with the identification of one entity as the acquirer and the other as the acquiree.

The next step involved determining the total cost of the acquired company. This cost included not just cash paid, but also the fair value of any other assets distributed, liabilities incurred, and equity interests issued by the acquirer. This total cost was then allocated to the specific assets acquired and liabilities assumed based on their individual fair value at the date of acquisition.

An outcome of this allocation process was the potential creation of goodwill. Goodwill arose when the total purchase price paid by the acquirer exceeded the sum of the fair values of the identifiable net assets acquired. Under APB 16, this resulting goodwill was recorded as an intangible asset on the acquirer’s balance sheet.

Once recorded, this goodwill was not permitted to remain on the balance sheet indefinitely. APB 16 mandated that the goodwill be amortized, meaning it was systematically charged as an expense against earnings over its estimated useful life. The opinion stated that the amortization period could not exceed 40 years. This requirement directly impacted the reported net income of the combined company for many years following the acquisition.

Supersession and Transition to Modern GAAP

The era of APB 16 ended due to a desire for improved financial reporting. The existence of two different accounting methods for similar transactions—pooling and purchase—was seen as a weakness. Critics argued that it allowed for different accounting results for economically similar business combinations, which hindered investors’ ability to compare companies. The pooling method was particularly criticized for obscuring the true economic cost of an acquisition and not reflecting the fair values of the assets acquired.

In 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 141, which officially superseded APB 16. This new standard eliminated the pooling of interests method entirely. It mandated that all business combinations be accounted for using the purchase method, subsequently referred to as the “acquisition method,” leading to greater transparency.

The principles introduced in SFAS 141 were later integrated into the FASB’s Accounting Standards Codification (ASC) as Topic 805. The transition to a single method was driven by providing more relevant information to users of financial statements. By requiring the recording of all assets and liabilities at their fair values, the new standard ensures that financial statements reflect the economic substance of the transaction.

The move away from APB 16 and the dual-method approach represented a change in the philosophy of accounting for business combinations. The focus shifted from the form of the transaction to its economic substance. The elimination of the pooling method and refinement of purchase accounting under ASC 805 have resulted in a more uniform and comparable approach to reporting these corporate events.