A study of proposed alternatives for accounting for business combinations

Abstract

The problem addressed in this research concerns the various methods available for accounting for business combinations. Currently there are two acceptable methods for accounting for business combinations- the purchase and pooling-of-interest methods. Both, at times, have been criticized severely in the accounting literature. As a response to this criticism an alternative method has been proposed which basically modifies the already existing purchase method. This modified purchase method has been espoused by several writers and the national accounting firm of Arthur Andersen & Co. The use of this modified purchase method of accounting for business combinations would at times result in different balance sheet and income statement amounts as well as different earnings per share and return on investment figures than would result from the use of currently generally accepted accounting techniques. The difference in these key financial figures brings up the question of whether the use of the modified purchase method of accounting for business combinations would elicit different investment decisions than would occur under currently acceptable accounting principles. This research study has as an initial objective, an examination of the theoretical merits and flaws of the three possible methods of accounting for business combinations. Secondly, an attempt was made to determine if the method chosen to account for a business combination influences a prospective investor's decision concerning a planned investment. Some might consider the question to be only one of logic or theory..