Pooling of interests method of accounting occurs during mergers and acquisitions which involves consolidating the balance sheets of the two companies into one balance sheet based on book values. However, companies have the option of excluding intangible assets e.g. patents, great customer base, good employee relations, brand name etc. from the consolidated balance sheet.
General Accepted Accounting Principles requires that transactions are to be recorded at the exact time they occur regardless whether cash was received or not, on the other hand companies had the option to not account for intangible assets on their balance sheet. Under GAAP, an expense is matched with the related revenue but under pooling of interests expenses that were associated with the business mergers or acquisitions were reported as part of the company’s comprehensive income.
By excluding intangible assets from the balance sheet, firms were hiding the acquisition cost of the merging process and as such providing inaccurate information on their balance sheet (which affected their income statement) to make them look more profitable to attract more investors.
Since goodwill were not reported for on the consolidated balance sheet, companies’ earnings looked way better than it was.
Quality of earnings is the extent to which earnings reported on the income statement of companies are attributed to core operating activities of the business. This is considered high when...