FASB Pooling Proposal Settled: Now Meet the IASB –

In late June, the Financial Accounting Standards Board (FASB) voted unanimously to issue new accounting standards for business combinations, thereby eliminating the use of “pooling of interests” accounting. Importantly, the new standards also contain significant changes to purchase accounting – changes sought by the National Venture Capital Association – that will make the elimination of pooling accounting more palatable to industry.

The vote by the FASB closes the book on a long and contentious fight that drew the attention and involvement of a broad cross section of industry, academia, Congress and the national press. The initial intention of the FASB was to eliminate the use of pooling accounting in favor of old purchase accounting rules, which would have forced the amortization of acquired “goodwill” in all combinations whether or not that goodwill was a wasting asset. While many in industry, legal, and accounting circles viewed the FASB proposal as a fait-acompli, the NVCA recognized the threat it posed and sprang into action. The final FASB standard – which puts in place an “impairment test” to determine whether or not the goodwill is actually depreciating – represents a significant turn-around from where the FASB started. The importance of this change cannot be underestimated given the increasing prominence of intangible assets in the valuations of companies.

A valuable lesson has come out of this exercise: the seemingly benign activities of an obscure organization like the FASB are complicated and amplified when applied to a changing or new economy. Close monitoring of future activities is warranted. The NVCA is doing just that and has identified more clouds on the horizon.

In a global economy, it is inevitable that standards be harmonized across borders. Earlier attempts in past years to harmonize accounting standards via an International Accounting Standards Committee (IASC) largely have been unrealized. Questions about authority, jurisdiction and funding inhibited its progress. The FASB and other accounting standards boards from several other countries in late 1999 decided to step up to the plate again. In the last year and a half they have worked to re-establish and slightly rename a new International Accounting Standards Board (IASB), which will be made up of accounting academics and professionals from member countries. Just out of the blocks this summer, the IASB has suggested an ambitious agenda including more than a few projects that will dredge up significant controversy.

Among a number of proposals, the IASB has announced its intention of seeking international accounting standards for business combinations, revenue recognition, and – in a move likely to draw the most controversy – expensing of stock options. Not surprisingly, the FASB made clear early on that, regardless of the IASB plans, they have no intention of revisiting this issue and supporting any such international project. They’ve been there before. In the mid-1990s, the FASB pursued its own project that would have required companies to expense stock options granted to directors and employees. After fierce resistance by the NVCA, the high-tech industry and, ultimately, Congress, the FASB dropped the proposal and opted instead for footnote reporting of options on financial sheets. Nonetheless, the IASB has already issued an academic paper calling for expensing stock options and they have consistently listed it as a project that they would like to pursue early on.

At this point, it is not entirely clear what authority the IASB will have in establishing standards that will be widely accepted across borders. In a move that portends trouble, the European Commission is pursuing regulations that would require “all EU companies listed on a regulated market…be required to prepare their consolidated accounts in accordance with a single set of accounting standards” (namely those prepared by the IASB) by 2005. If this regulation is put into place – and it appears that the process to do so is well on its way – it will greatly enhance the authority of the IASB. Whether or not the FASB will be in a position after that to resist and reject international standards that it disagrees with is a tough question. Its answer will be critically important.

Creating generally accepted accounting principles that adequately value companies and accurately record their activities is exceedingly difficult in the New Economy. As the FASB has learned, it is also a potential source of great controversy. New business models and companies rich in intangible assets have made financial reporting and the problems associated with it front page news. Industry must remain vigilant so that, in responding to these new challenges, the FASB, the IASB and other regulatory bodies get it right.

Thomas McConnell is a general partner at New Enterprise Associates in Menlo Park. He is also chairman of the NVCA Board of Directors.