And GoodWill To All

I should make a T-shirt. One that says, "When I was your age, I could use pooling accounting on my merger."

Pooling was disallowed, of course, in 2001. It allowed companies to avoid goodwill and thus save a temporary hit to EPS. Strange, huh? Accounting choice did not affect future cash flows. The investors shouldn't care. But management did. EPS mattered dearly.

Most of you understand the heart of the matter here, and if so, skip to the next paragraph. If not, the gist is as follows: In merger waves, acquirers tend to pay higher than book value for target firms. This is problematic, because accounting generally deals in book value. Two versions evolved. The first, called Purchase Accounting, forced the acquirer to book the excess as goodwill and depreciate it. The second, Pooling Accounting, allowed the bidder to add the target at book value. The advantage to the latter is that it allowed the bidder to avoid future years of goodwill expense.

Anyway, while the Accounting Gods banned pooling, they tossed a bone to these guys. Although you had to use purchase accounting, you didn't have amortize the goodwill.

This was great! Although you couldn't use a favorable accounting treatment, you could at least defer the expense until your accountants told you it was "impaired". Since asset values trended up, you should be good to go.
Enter: Recession.

Your accountants are not smiling. "Fred", they say, "that acquisition we did in Dec 2006?"
"Yeah"
"We have to write it off. This 'goodwill' is gone."

Repeat this game across the S&P 500, one is bound to see the earnings year we saw in 2008. My guess is that many managers, in hindsight, would have loved to amortize some of this goodwill during the good times.

In short, current accounting laws require firms to take giant earnings hits in bad times. It allowed management to dodge slightly worse EPS in periods immediately following the merger, but if it causes myopic behavior in bad times, perhaps the treatment should be looked at.