EXAMPLE: WHO CONTROLS WHOM? For some combinations it is difficult to infer who controls whom. For example, on April 6, 1998, Citicorp and Travelers Group an nounced an agreement to merge to become a global financial service provider. The merged firm, Citigroup Inc., served over 100 million customers in 100 countries around the world and had interests in traditional banking, consumer finance, credit cards, invest ment banking, securities brokerage and asset management, and property casualty and life insurance. Under the merger, each company's shareholders owned 50 percent of the combined firm. Citicorp shareholders exchanged each of their shares for 2.5 shares of Citigroup, whereas Travelers shareholders retained their existing shares, which automat ically became shares of the new company. The new firm also announced that John S. Reed, Citicorp's Chairman andCEO, and Sanford I. Weill, the chairman andCEOof Travelers, would serve as cochairmen andcoCEOs of the merged firm. In the Citicorp-Travelers combination, it is not clear which company is the acquirer and which the acquired. How, then, should accounting reflect this combination? The boundaries of the new entity are clear. But what is the value of its assets, liabilities, rev enues, and expenses? Given the difficulty in identifying which party is the acquirer, ac countants have historically simply summed up the two firms' financial statements. Under this approach, called "pooling-of-interests," the consolidated financials are the aggregated book values of the two firms' individual statements. In contrast to the Citicorp-Travelers merger, most combinations do have an identifi able acquirer and target. For these types of investments, investors want to know how much the acquirer paid for the target firm and whether the investment creates value for shareholders. The pooling-of-interests approach does a poor job of providing this type of information, since it consolidates the two firms' financial statements at their book val ues. Acquirers typically pay a considerable premium over book value, and even over pre acquisition market value, to take control over other companies. The second method of consolidation, called purchase accounting, provides more rel evant information by combining the target firm's assets and liabilities into the balance sheet of the acquirer at their market values. Any difference between the price the ac quirer paid for the target firm's equity and the market value of the separable net assets is then reported as goodwill. Goodwill is subsequently amortized over as many as 40 years, or in some countries is written off if there is evidence of impairment.

One challenge in accounting for business combinations has been in assessing when pooling-of-interests or when purchase values provide more relevant information for in vestors. UnderAPB 16, firms were required to use the pooling method when both partners had been autonomous companies for more than two years, the deal was largely a stock swap, voting and dividend rights for shareholders were unchanged, and there were no ma jor asset sales for at least two years following the combination. Otherwise, acquisitions have to be accounted for using the purchase method. However, in April 1999, the FASB proposed new rules that would require all mergers and acquisitions to be reported using the purchase method and would limit the maximum life of goodwill to twenty years.

Several opportunities for financial analysis arise from the difficulty in assessing whether one company has control over another. First, accounting rules provide management with some latitude in entity reporting. Management can use this dis cretion to ensure that financial statements reflect the underlying entity's perfor mance. However, it can also seek to omit important resources or commitments from the firm's financial statements. Second, accounting rules require a firm to consolidate, to use the equity method, or to mark an investment to market. In con trast, the degree of control that one company has over another lies on a continuum between no control and complete control. Consequently, the information generat ed by entity accounting rules is unlikely to reflect all of the subtleties associated with control. Given these challenges, the following questions are likely to be use ful for analysts:

1. What are a major investments in other companies? What percentage of these companys' stock does it own? Who are the other key owners of the same firms, and how much stock do they own? Is there other evidence of a firm's control over others, such as representation on the boards of directors?
2. What are the assets and leverage of related companies that are not consolidateed? Does the investor's management appear to be using its reporting discretion to keep key resources and commitments off the balance sheet? What isthe performance of related companies that are not accounted for using the equity method? What are the investor management's incentives for this reporting choice?
3. How have significant acquisitions been recorded? Does management of the acquirer appear to have used the pooling-of-interests method to avoid show ing the full cost of the acquisition? If so, what was the effective cost of the acquisition? Has it generated an adequate return for shareholders? If the purchase method has been used, has the acquirer been forced to write down the value of the assets it acquired?