FOR IMMEDIATE RELEASE: CONTACT: CHRISTI HARLAN
Wednesday, June 14, 2000 202-224-0894

GRAMM'S STATEMENT AT ROUNDTABLE DISCUSSION
OF ACCOUNTING FOR GOODWILL

Sen. Phil Gramm, chairman of the Senate Committee on Banking, Housing and Urban Affairs, made the following statement today at a roundtable discussion of the treatment of goodwill under proposed new accounting standards for corporate mergers:

"This is a subject that is vitally important to the American economy. It is one that members of Congress, at least, are woefully ignorant about. We have great concerns about it; we may have some theoretical knowledge of it, but most of us, other than Senator Mike Enzi, who is a CPA, have no real practical experience in this area.

"Rather than having a standard hearing where we give a statement, witnesses give a statement, and there might be a relevant question, but almost no interchange, I thought we would be a lot better off having this roundtable discussion.

"First, I want to thank the Financial Accounting Standards Board. I think the board, by and large, does a very good job. They have a difficult job. Any time you are making decisions that involve hundreds of billions of dollars of resource evaluation, you're going to have winners and losers, and you're going to have political controversy.

"I think we have wisely decided to have an independent board to set accounting standards in the United States. It has been suggested, from time to time, that the Securities and Exchange Commission might have too much influence over the FASB. I think some critics believe that Congress has too much influence, but that's very difficult for me to believe.

"In any case, I want to make it clear to FASB chairman Ed Jenkins that we're very grateful for what the board has done. We have the best accounting standards in the world. We lead the world in this area.

"What we want to do today is to be sure we understand what is being proposed. We want to afford ourselves and you an opportunity to hear from people who agree and disagree. Basically, the problem is very easy to define, for me, when I can remember which is which, that is, pooling versus purchase accounting. It is a very difficult problem to solve.

"The basic problem with pooling accounting is that when two companies merge, or one acquires another, by simply looking at book value, you create a balance sheet that in no way reflects the reality of the new company. One could argue that it grossly overestimates the return on equity because you have an artificial measure of equity, that is, the book value of the combined companies.

"For example, when Netscape was acquired by AOL, it had a book value of about $500 million. The acquisition cost was about $10 billion. Obviously, AOL thought Netscape was worth a lot more than its book value. But yet, in using pooling-of-interest accounting, that $9.5 billion cost didn't show up on the books.

"I'm not arguing that accounting has to be an exact portrayal of reality. In fact, accounting can be demonstrably false from the point of view of behavior but very good from the point of view of approximation. Accounting is trying to approximate reality, not necessarily explain it.

"In a financial snapshot at the point of an acquisition, I would argue that purchase accounting is superior to pooling of interest. The problem comes, however, in that purchase accounting requires that this goodwill be written down over time, even though, in any successful merger, we expect the value of that goodwill to rise and not to decline.

"The question then becomes, are the problems created by arbitrarily writing down goodwill sufficient to override the benefits in approximating reality that we get from purchase accounting? Is there a way you can develop some approximation that would allow you to assess periodically the value of goodwill and determine whether or not it's being preserved, whether or not it's declining, whether or not it's actually rising in value?

"To what extent are the earnings of a company after the purchase occurs a reflection of what has happened to goodwill? You run into problems because you don't know what the buyer expected to happen, and the purchase price was based on that expectation. Is there a way you can develop a rule of thumb that would allow you to evaluate goodwill periodically and determine whether it is declining, in which case you write it down; whether it is growing, in which case you might increase it; or whether it has stayed the same, in which case you leave it alone.

"There are a lot of other issues, but it seems to me, from the point of view of wanting an accounting system that works economically, that's the dilemma."

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