MHM Executive Education Series Webinar: Valuation … EES... · Valuation Issues in Financial...

MHM E ti Ed ti S iMHM Executive Education Series:Valuation Issues in Financial Reporting

Presented by:James Comito, Keith Peterka

October 18, 2012

Agenda

• Identifying accounting transactions that commonly result in valuation issues for the accountant and auditor

• Managing both the risk associated with valuation issues and the related cost of valuation work

• Using the work of a specialist; a review of the relevant auditing standards and practical considerations to improve communication between, management, auditor and valuation experts

• An overview of recent changes to the model for assessing impairment for goodwill and infinite lived assets, including: – Step 0 requirements– Review of steps 1 and 2 for the goodwill impairment

Overview of Valuation Issues

• Valuation Definition – The process of estimating what something is worth.

• Financial instruments (assets and liabilities), business ( ),enterprises, intangible assets, and liabilities.

• Valuations are needed for a variety of reasons such as investment analysis, tax planning and reporting, risk y , p g p g,management and analysis and financial reporting and analysis.

– Virtually all valuation exercises are by their nature extremely y y ysubjective.

Overview of Valuation Issues• Common Valuation Models• Common Valuation Models

– Absolute value models. Such models are based on the present value of an asset's expected future cash flows. In practice, absolute value models typically appears in two different forms:absolute value models typically appears in two different forms: multi-period models such as discounted cash flow models or single-period models (e.g., the Gordon model). Absolute value models are reliant on mathematics rather than price observation.models are reliant on mathematics rather than price observation.

– Relative value models. Such models determine value based on the observation of market prices of similar assets.Option pricing models These models are used for certain types– Option pricing models. These models are used for certain types of financial assets (e.g., stock warrants, put/call options, stock options issued to employees, financial instruments that contain embedded options. The Black-Scholes-Merton model and latticeembedded options. The Black Scholes Merton model and lattice models are the best known option pricing models.

Overview of Valuation Issues• Over the past few years several factors have contributed to the• Over the past few years several factors have contributed to the

increased focus on valuation issues faced by the financial reporting community.

The recession and subsequent uncertain economic environment– The recession and subsequent uncertain economic environment– Increased use of fair value measurements by standard setters– Increased complexity related to business and asset valuation,

fi i l i t t d i k t t t ifinancial instruments and risk management strategies– Increased scrutiny by regulators of fair value measurements – Changes to the fair value financial reporting model

• Active versus distressed markets • Use of multiple valuation techniques• Increased disclosure requirementsIncreased disclosure requirements

Identifying Valuation Issues

• Accounting Transactions that Often Result in Complex Valuation Issues – Business acquisitions – Impairment assessmentsp– Debt extinguishment– Investments in securities of private entities

Derivative instruments including embedded features– Derivative instruments, including embedded features– Equity transactions that involve the securities of private entities– Share-based compensation arrangements

Managing Valuation Issues for Success

• Cost versus benefit– The goal of management is to achieve compliance with the

authoritative guidance while managing the cost of achieving such compliance.

– The simple fact is that valuation issues typically result in additional cost.

– The amount of additional cost is dependent on many factors, however, a significant factor is the assessment of risk related to the valuation issue.

• Many valuation issues stem from significant transactions that are material to the financial statements. However, this is not always the case.

• Management and the auditors response to valuation issues should be risk based.


• Management’s decision to use a valuation specialist– If a valuation issue has been identified as high risk the use of a

valuation expert will likely be necessary.– Most management teams lack the required expertise to

adequately address the authoritative guidance pertaining to valuation issues.

– Management may be able to reduce the amount of cost paid to a valuation expert by performing much of the required analysis under the guidance and direction of the valuation expert.

– Understanding the documentation needs of the auditor and designing the valuation analysis to address these needs may reduce the amount of effort required by the auditor to obtain comfort on the transaction thereby reducing audit cost.


• The auditors’ decision to use a valuation specialist– Under existing auditing standards, when a valuation issue has

been designated as high risk; the audit team will almost always be required to engage a valuation expert to assist the audit team.

– Ensuring the expert engaged by management and auditor expert participate in timely discussion of management’s plan to address the valuation issue is essential to an effective and efficient conclusion on the matter.

– Waiting until the end of an engagement to address valuation issues almost always results in frustration and costs that might have been avoidable. Early identification and risk assessment related to valuation issues is the key to an effective and efficient

l i th ttconclusion on the matter.

Using a Valuation Specialist

• Considerations for Management– Remember the auditor must assess the management specialist

capabilities in relationship to the valuation assignment. Management should as well.

– Hiring the right person for the job is critical.– Management must demonstrate the expert is qualified, g p q ,

competent and objective enough to perform the assignment. – There are many qualified valuation specialists that are narrowly

focused on a particular niche market. For example, an expert p p , pthat focuses on valuing property in divorce settlements may not be an appropriate choice for an assignment related to valuing intangible assets in a business combination.


• Considerations for Management– Make sure the specialist is familiar with FASB ASC 820, Fair

Value Measurements. Although this standard can no longer be considered “new”, consistent valuation standards have still not been issued. Hence, many valuation specialists never truly adopted the ASC 820 requirements. The use of the term “fair

k t l ” i th i t i l i di t i ith ASCmarket value” in their material may indicate an issue with ASC 820 compliance.

– When obtaining valuation assistance for financial reporting th t l tt ith l tipurposes ensure the engagement letter with your valuation

specialist acknowledges the appropriate financial reporting framework.


• Considerations for Management– A primary focus of the valuation specialist is assisting

management with the identification of the appropriate valuation technique.

– Remember, ASC 820, requires management to at least consider all three acceptable valuation techniques.

• Income approach• Market approach• Cost approachCost approach

– Often management may be comfortable with an income approach (discounted cash flow analysis), however, the market and cost approaches are generally more difficult to navigateand cost approaches are generally more difficult to navigate.


• Considerations for Management– Once the valuation technique(s) has been identified the

necessary data must be gathered and critical assumptions must be made by management.

– The valuation specialist can assist management with its assumptions, however, ultimately it is management that must assume the responsibility for the assumptions and final conclusion.

– Watch out for inconsistencies with other company information.• Current company budget projects 5% revenue growth while

the valuation exercise uses 7.5%.


• Considerations for Management– Once the appropriate valuation techniques have been selected

by management (with assistance from the expert); management, management’s expert, the auditor and the auditor’s expert should meet to discuss the approach selected by management for the valuation exercise.

– There is no more frustrating feeling that completing a valuation exercise only to have an auditor’s expert object to the selected approach.

– The assumptions can always be debated; but the basic mechanics of the valuation approach should be agreed to in advance of the data gathering and analysis portion of the

iexercise.

Some Common Valuation Problems

• Business combination example– Company X acquires a small entity for its manufacturing

capacity. Management believes the only assets that will be useful are tangible in nature and therefore does not feel the need to engage a valuation expert.

– The auditor of Company X is concerned that “other” assets may also be part of the acquisition.

• Customer list• Certain contracts• Patents and/or trade names and trade marks• Research projects which qualify as IPRD (in-process

research and development)research and development).


• Business combination example– The last round of changes to the accounting for business

combinations removed the ability for management to rely on its stated “intention” as a basis for assigning value to an asset(s).

– The mindset of the “market participant” now governs the assignment of value in a business combination.

– These changes combined with earlier efforts by the standard setters to require recording of certain intangible assets that meet the “legal/separation” criteria make it very difficult for management to comply with the authoritative standards without assistance from a valuation specialist.


• Goodwill impairment example– Company X management performs its annual impairment test

related to goodwill by identifying the appropriate reporting units and preparing a discounted cash flow analysis (income approach) to assess whether the goodwill related to each reporting unit is impaired.

– The auditor of Company X asks whether the market approach was also considered and if so, how it impacts the final conclusion related to impairment.

• Most financial executives are familiar and comfortable with discounted cash flow analysis. However, fair value guidance requires the consideration of all three allowable techniques and the

k t h ft h b d li bilit Oft f thimarket approach often has broad applicability. Often for this reason a valuation expert is needed by management.


• Private company securities example– Company X is a private entity that issues share-based

compensation to its employees. During the year under audit the company issued one million stock options to members of its board of directors and executive level employees. Company X has never had formal valuation work performed to determine the

l f it t k C t k i i t i t thvalue of its common stock. Common stock is an input into the option pricing model (Black Scholes Merton) used by Company X to determine the value of share-based compensation issued to its employees for financial reporting purposesits employees for financial reporting purposes.

– Company X’s auditor is concerned that without independent valuation work related to the price of Company X’s common stock the value assigned to share based compensation may bestock the value assigned to share-based compensation may be materially misstated.


• Private company securities example– Currently, there is not an absolute requirement in either

generally accepted accounting principles or generally accepted auditing standards that require independent valuation work.

• However, for publicly traded companies the Securities and Exchange Commission has stated its belief that certain transactions such as a significant business combination would be difficult to properly record without appropriate valuation expertise.


• Private company securities example– Determining the best course of action is often a matter of

precision. The higher the risk assigned to the valuation issue the higher the precision that will be needed in determining the value.

– For example, instead of one million stock options, assume only 10,000 were issued. It would likely take far less precision for management and its auditor to conclude on the issue.

– When management and its auditor conclude that a high degree of precision is necessary because of the risk of material misstatement to the financial statements; the use of a valuation specialist becomes virtually a certainty.

Goodwill Impairment Testing• U.S. GAAP Requires* an Impairment Analysis on an Annual basis.U.S. GAAP Requires an Impairment Analysis on an Annual basis.

– Test to be Performed in the interim if indicators exist.– * Step 0 - Qualitative Assessment Allowed.

Goodwill Impairment Models is a Two Step Analysis• Goodwill Impairment Models is a Two Step Analysis– STEP ONE identifies potential impairment by comparing Fair

Value of a Reporting Unit to its carrying amount.• Fair Value is to be determined in accordance with ASC 820• Reporting Units to be determined in accordance with ASC

280Practice Pointers

Fair Value of the Reporting Unit must be from the viewpoint of a Market Participant.

Fair Value is developed using the approach(s) outlined in ASC 820 Reporting Fair Value is developed using the approach(s) outlined in ASC 820. Reporting Entities must be able to support the approach, and the weighting of the methodologies. A CASHFLOW (Income Approach) is not enough!

Goodwill Impairment Testing

Step Two of the Goodwill Impairment Model requires the use of a Hypothetical Purchase Price Allocation, which is used to recognize and measure impairment. – Purchase Price Allocation is based off of the Step One Fair Value.

Discussion Question If a reporting entity fails Step One (Carry Value of Reporting Units above Fair Value) is it possible not to have a Goodwill Impairment Charge in Step Two, and why?

Reporting Units

ASC 350 requires goodwill to be assessed for impairment at the reporting unit level, which is defined as an operating segment (before aggregation), or one level below an operating segment (i.e., a component).

ASC 350-20-35-34 states, A component of an operating segment is , p p g ga reporting unit if the component constitutes a business for which discrete financial information is available and segment management, regularly reviews the operating results of that component.

Segment Reporting – Management ApproachT d t i ti t th fi t t i t id tif thTo determine operating segments, the first step is to identify the entity’s chief operating decision maker (CODM). The term CODM identifies the decision making role within an organization and not necessarily an individual with a specific titlenecessarily an individual with a specific title. ASC 280 defines an operating segment as a component of a business entity that has each of the three following characteristics:

1. The component engages in business activities from which it may earn revenues and incur expenses.

2 The operating results of the component are regularly reviewed by the2. The operating results of the component are regularly reviewed by the entity’s CODM to assess the performance of the individual component and make decisions about resources to be allocated to the component.

3. Discrete financial information about the component is available.3 sc ete a c a o at o about t e co po e t s a a ab e

Identification of Reporting UnitsPractical ConsiderationsPractical Considerations

Identification of reporting units is not a standard procedure for private companies, and must be well documented. D i i f ’ ibili i Documentation is part of management’s responsibilities.

Number of reporting can change with changes in management and operations.

No “industry standard” for determining reporting units for an industry.

ASC 280 Introduces the concept of the “Chief Operating Decision Maker” (CODM), critical to understand how the entity fills this role.

Need to have sufficient audit support. Key question “What does the Board/CEO use to make resourcing decisions?

Reporting Units Allocation• Basis for allocating assets and liabilities to various reporting units• Basis for allocating assets and liabilities to various reporting units

must have a supportable basis.• Challenges with Intangible Assets such as patents and trademarks.

M i th f l ti i li t– May require the use of valuation specialist.– For example the allocation of a Trademark

Apply royalty rate to each reporting unitA hi f th t d k b t th ld d t– Assumes no ownership of the trademark, but rather would need to lease it (Relief from Royalty).

One reporting unit assume ownership and the other reporting units rents the trademark.

Other Approaches– Assign carrying value based on benefits received (Revenue or EBIT)– Assign carrying value based on relative fair values of reporting units

Shared Asset - Trademark

Recap of Possible Ways to allocate a Trademark– If reporting unit pays a royalty, it does not assume

ownership thus no carrying value assignedownership, thus no carrying value assigned– If reporting unit receives royalty, it assumes

ownership and carrying value is assignedp y g g– If reporting units are assigned carrying value, then

ownership is assumed, thus no need for royalty payments in cash outflowspayments in cash outflows

Assigning Goodwill to a Reporting Unit

How Should Goodwill be assigned to Multiple Reporting Units?

Assign upon acquisition based on expected benefits Assign upon acquisition based on expected benefits Goodwill can be assigned to reporting unit even thought assets or

liabilities are not assigned Methodology must be reasonable and supportable and applied in a

consistent manner

Reason for Changing the Goodwill StandardStep Zerop• Addresses private companies’ concerns about the cost and

complexity of the goodwill impairment test.

• Simplifies how entities, both public and nonpublic, test goodwill for impairment.

• Improves previous guidance by expanding upon the examples of events and circumstances that an entity should consider between

l i i t t t i d t i i h th it i lik l thannual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.

• FASB may readdress goodwill accounting in the future.

Reason for Changing the Goodwill StandardStep Zerop• The revised standard allows an entity first to perform a qualitatively

assessment whether it is necessary to perform step one of the two-step annual goodwill impairment test. An entity is required to perform step one only if the entity concludes that it is more likely than not that a reporting unit's fair value is less than its carrying amount.

• Provides examples of events and circumstances that an entity should consider when performing the qualitative assessment.

• An entity can choose to perform the qualitative assessment on none, some, or all of its reporting units. , p g

Reason for Changing the Goodwill StandardStep Zerop• The revised standard removes the guidance that allows an entity to

carry forward the fair value of a reporting unit under certain conditions.conditions. – The revised standard requires an entity to consider, as part of its

qualitative assessment, the difference between the fair value and the carrying amount of a reporting unit if the entity has a recent fair value calculation.

– The existence of a recent fair value calculation, and the extent of any "cushion" between a reporting unit's fair value and its carrying amount, will be an important factor when determining whether to perform thewill be an important factor when determining whether to perform the qualitative assessment. The qualitative assessment may be more cost effective when a reporting unit's fair value substantially exceeded its carrying amount in a prior period and no significant adverse changes have since occurred.

Reason for Changing the Goodwill StandardStep Zerop

– The FASB noted in its basis for conclusions, the more time that has elapsed since a recent fair value calculation, the more difficult it may be to support a conclusion based solely on a qualitative assessment. The frequency with which an entity refreshes its fair value calculation for a reporting unit will also depend on a variety of factors, including how much "cushion" existed at the last fair value calculation and the significance of any adverse changes since that datesignificance of any adverse changes since that date.

Events and CircumstancesDescription Examples

Macroeconomics General economic conditions, limitations on access to capital, general debt and equity market conditions, FX issues

Industry & market conditions E tit i t h i lti l d t iIndustry & market conditions Entity environment, changes in multiples and metrics, product/service demand issues, regulatory or political developments

Cost/expense factors Materials, labor and other factors impacting earnings

Financial performance Cash flow trends, variance analysis over relevant periods

Company-specific events Changes in management, key personnel, strategy, loss of customers, pending bankruptcy of litigation

Reporting-unit specific events Change in composition or carrying values of assets, asset group or subsidiary changes, disposal of a portion of a reporting unit

C it l k t i i S t i d d i h i (b th i b l t dCapital market pricing Sustained decrease in share price (both in absolute and relative to peers)

Events and Circumstances• During the assessment, an entity should consider each adverse

factor as well as the existence of any positive and mitigating events and an entity should place more weight on those events and circumstances that most significantly affect a reporting unit's f i l i tfair value or carrying amount.

• Understand which factors are the key drivers of each reporting unit's fair value and monitor changes in those factors.

• Identify both the internal and external sources for information yneeded to monitor the relevant factors for each reporting unit.

Amendment of ASC 350

• In September 2011, FASB issued Accounting Standards Update No. 2011-08 (ASU 2011-08), an amendment of ASC 350. FASB’s intention in issuing ASC 2011-08 was to simplify how public and nonpublic entities test goodwill for impairment The qualitativenonpublic entities test goodwill for impairment. The qualitative assessment permitted under ASU 2011-08 is commonly being referred to as “Step Zero” by many practitioners.

• The amendment will be effective for annual and interim goodwill gimpairment tests performed for fiscal years beginning after December 15, 2011.

• Amends the examples of events and circumstances that an entity h ld id b t l i i t t t i d t i ishould consider between annual impairment tests in determining

whether it is more likely than not (that is, a likelihood of more than 50 percent), that the fair value of a reporting unit is less than its carrying amounty g

Amendment of ASC 350

An entit ma res me performing the q alitati e assessment in an• An entity may resume performing the qualitative assessment in any subsequent period.– Not an Accounting Policy election.

• Allows companies an “unconditional option” to skip the optional• Allows companies an unconditional option to skip the optional qualitative assessment and continue applying the existing two-step test

• Requires no new disclosuresq– 2011 AICPA PCAOB and SEC Conference, SEC Staff noted that it

would expect that when the qualitative assessment is used it is disclosed.Best Practice for all reporting entities– Best Practice for all reporting entities.

I it

Goodwill Impairment Assessment Decision Tree

QualitativeAssessment

FV < CV

Is it more likely

than not FV < CV

StopNo

No

Yes

Is

No

Is the FV of RU < CV of

RU

Step 2Is

implied FV of

GW < CV of GW

YesStep 1

FV = Fair ValueCV = Carrying Value

Yes

Recognize Goodwill

GW = GoodwillRU = Reporting Unit

Goodwill Impairment

Implementation Guidance For Performing Step Zero

1. Determine/identify key assessment factors for each reporting unit― While the process is deemed qualitative, many of the assessment factors are

quantitative― Remember that factors other than those listed in the ASU may be relevanty― Consider factors used in a typical fair value determination as well

2. Develop and collect key market-based metrics– Capital market pricing for comparable companies (relative pricing) and equity

k t it li ti if bli ( b l t i i )market capitalization, if public (absolute pricing)– Changes in valuation metric(s) over measurement period

3. Establish process to measure, compare and identify changes in key factors in subsequent periodsq p― Actual vs. budgeted results― Changes in key performance metrics― Changes in external environment – economy and industry

Implementation Guidance For Performing Step Zero

4. Compile and document the positive, negative and mitigating events and factors in subsequent periods― Prepare a presentation or matrix of factors considered, their effects on the

assessment and their relative weights.assessment and their relative weights.

5. Documentation of the process and the presentation of the results will be key components of a success Qualitative A tAssessment.

Goodwill Impairment Testing ASC 350Pursuant to accounting rules under ASC Subtopic 350-20-35-1,Pursuant to accounting rules under ASC Subtopic 350 20 35 1, goodwill and certain intangibles are not amortized; rather, these assets must be periodically tested for impairment

Two Step Goodwill Impairment Test1. Step One impairment test compares the fair value of a reporting unit

to its carrying value If the fair value exceeds carrying value there isto its carrying value. If the fair value exceeds carrying value there is no goodwill impairment and the test is complete. If not, impairment is indicated, requiring a Step Two impairment test.

2 Step Two which is similar to an allocation of purchase price2. Step Two, which is similar to an allocation of purchase price performed pursuant to ASC 805, calls for comparing the fair values of a reporting unit’s assets to their carrying values and quantifies the amount of goodwill impairment.g p

STEP ONE PRACTICE ISSUESDetermining the Fair Value of a Reporting Unit

Two generally accepted premises for determining the Fair Value:

1. Equity value (generally the market capitalization of the ) l f d t " k t l " " ff l "company), also referred to as "market value" or "offer value",

2. Enterprise value (generally the fair value of the equity and the debt), also referred to as "firm value" or "transaction value", is most simply defined as equity value plus net debt Net debtmost simply defined as equity value plus net debt. Net debt equals debt & equivalents minus cash & equivalentsExample - A business is formed by investing $100K cash, and borrows an additional $200K, the "equity value" for the business would b $100K t th t i l ld b $300K ($100K i itbe $100K, yet the enterprise value would be $300K ($100K in equity value plus $200K of debt.) As shown by this example, equity value represents the value to the contributors of equity into the business, whereas enterprise value represents the value for all contributors of

it l (i thi th f th b i ll th d btcapital (in this case, the owner of the business as well as the debt holder)

STEP ONE PRACTICE ISSUESReporting Units with Negative Equityp g g q y

The EITF resulted from questions pertaining to whether a reporting unit’s carrying amount should be based on an enterprise value (EV) premise or an equity level value premise. Alth h thi i i ifi t i it i ll iAlthough this is a significant issue on its own, especially in situations where the fair value of debt differs from its book value, this issue was further magnified by situations where the carrying value of equity was zero or negative. In these instances, thevalue of equity was zero or negative. In these instances, the method for calculating the carrying value would result in different conclusions in a step 1 test; either goodwill impairment is indicated and step 2 is needed or no goodwill impairment is indicatedindicated.

Perform qualitative assessment If it is more likely than not that impairment is present, proceed to

Step 2Step 2

42

Determining Step One Fair Value

Best Fair Value Evidence? Quoted Prices in Active Markets (Level 1 Measurement) however… It is Rare that a Reporting Unit will have an active market Private Company’s do not have active markets

Since Private Company’s and Reporting Units do not have ActiveMarkets (Level One Measurement) Reporting Entities will need toincorporate market participant assumptions with valuationincorporate market participant assumptions with valuationmodels.

Market Participant ConsiderationsWhat assumptions would be used in pricing the assets ofWhat assumptions would be used in pricing the assets of the reporting unit?

- Strategic Buyer or Financial Buyer?

Would market participants use the reporting units net assets the same manner?assets the same manner?– Standalone value to reporting units?– Exploit synergies among reporting units?

Taxable or Nontaxable Basis?

Valuation ApproachesThree Allowable Approaches:Three Allowable Approaches:

– Income approach, Market approach & Cost Approach• Cost Approach used more to value individual assets, not commonly

d t l ti itused to value reporting units.

Common Methods Used to Value a Reporting Unit• Discounted cash flow (DCF) method (Income approach)• Guideline public company (GPC) method (Market Approach)• Guideline transaction (GT) method (Market Approach)Guideline transaction (GT) method (Market Approach)• Market capitalization method (Market Approach)

Discounted Cash Flows Method

Keys of the DCF ModelProspective financial information (PFI)

THIS IS THE STARTING POINT• THIS IS THE STARTING POINT• Discrete period cash flow

– May need adjustment to be “Market Participant”

T i l h fl• Terminal cash flows– Valuation Concept

Long-term growth rate and Discount rate used will have a major impact on the DCF.

Practice Pointer – Using a “Conservative "Discount rate does not cure gpoorly prepared and supportable cash flows.

Key Information Need for the DCF Analysis

PFI development– Strategic plans– Budgetsg– Prior forecasts– Benchmarking studies– Board or banker presentationsp– Analyst coverage

Practice Pointer – PFI information will start out very much entity focused, it will y y ,require adjustments to become market participant data assumptions


PFI development - How long?– Comfortable making estimates

Stabilized or Constant– Stabilized or Constant • Growth• Reinvestment in business

R t f t• Rate of return– On new invested capital– On base invested capital

P ti P i tPractice PointerCash flow analysis typically is for 4-5 years, but there is not set standard.


PFI development Common Fair Value Adjustments• Planned acquisition activity• Working capitalWorking capital • Deferred revenue• Non-operating assets and liabilities

L l f f ti it• Legal form of reporting unit• Depreciation and amortization• Share based compensation• Fixed and variable costs• Income tax rate• Related party transactionsRelated party transactions• Interest bearing operating debt

DCF – Long Term Growth Rate

Long-term growth rate – Critical Component– The long-term growth rate indicates the growth the

b i ill h ld i t t itbusiness will hold into perpetuity– For a business that is a going concern, this rate is

typically between 2% and 5%typically between 2% and 5%– Assessing Terminal Growth Rate

• Management expectations• Industry long-term growth prospects• Inflation prospects• Has business stabilized?


PFI development – key takeaways– Can enlist help to develop PFI– Ultimately management responsibility– Goal is to end up with market participant cash flows

Market Approach Guideline Public Company Method (GPCM)Method (GPCM)

Uses information of publically traded comparable companies

Usually thought to begin at a minority valueM b bj t t t l i• May be subject to a control premium

Guideline Public Company Method

General Steps to Using GPCM– Select guideline companies

Determine most relevant value multiples– Determine most relevant value multiples– Calculate market multiples for guideline companies– Evaluate whether adjustments to financial metrics are necessary

t i t li d t i ( k t ti )to arrive at normalized metrics (market assumptions)– Apply selected multiples to subject company financial metrics – Apply control premium, if applicable


Select guideline companies• Comparability factors• Similar operational characteristics

– Same industry (SIC)– Lines of businessLines of business– Geography– Customers or distribution channels

Business cycle– Business cycle– Stage in business life cycle

Practice Pointer – These factors need to be well documented.


Select guideline companies– Comparability factors– Similar financial characteristicsSimilar financial characteristics

• Size• Performance or profitability• Future growth• Future growth• Asset base• Own vs. leased property• Amortization and depreciation policies• Amortization and depreciation policies• Inventory policies

Guideline Public Company Method Determine most relevant value multiplesDetermine most relevant value multiples

– Numerator• BEV or• Equity

– Denominator:• Revenue• EBITDA

EBIT• EBIT• Net income • Total assets• Book equityBook equity

– Denominator timeframe:• Last twelve months (LTM)• Last fiscal (LFY)• Last 3 year average

– Non-financial metrics


Calculate market multiples for guideline companies– Analysts can do this on their own.– Database services make these calculations usually for a feeDatabase services make these calculations usually for a fee.– These can be adjusted to enhance comparability.

Evaluate whether adjustments to financial metrics are necessary– Objective is to reflect normalized operations

• Remove non-operating activityp g y• Remove atypical activity• Address intercompany arrangements in effect• Address intercompany arrangements not reflected• Address intercompany arrangements not reflected


Apply selected multiples to subject company financial metrics– When more than one multiple is selected, a weighting effort is

needed• Should reflect relative importance • Ranges can be narrow or wide• Selection should demonstrate careful considerationSelection should demonstrate careful consideration

– A straight average is not necessarily the best


Step Two of the Goodwill Impairment Model requires the use of a Hypothetical Purchase Price Allocation, which is used to recognize and measure impairment. – Purchase Price Allocation is based off of the Step One Fair Value.

Discussion Question If a reporting entity fails Step One (Carry Value of Reporting Units above Fair Value) is it possible not to have a Goodwill Impairment Charge in Step Two, and why?


Discussion Question Yes. The Goodwill Impairment Test is the last impairment analysis to be completed by a reporting entity. Meaning current assets (Inventory) Long Lived Assets, and Other Indefinite Lived Intangibles Must be tested prior to Goodwill.

• This is critical so that the correct carrying value of the Reporting Unit is used in the Goodwill Analysisin the Goodwill Analysis.

The reason no Goodwill Impairment could result when performing Step Two of the analysis is due to the different basis of which the impairment models are performed. This could happen when a Company has a significant amount of Fixed Assets (Long Lived Assets) who’s Fair Value is lower than their Carrying Amount. It is possible since the Long Lived Asset model is based on an UNDISCOUNTED cash flow analysis.

ASU 2012-021

The FASB issued final guidance adding an optional qualitative assessment for determining whether an indefinite-lived intangible asset is impaired. The guidance in the ASU gives companies the

ti t fi t f lit ti t t d t i h thoption to first perform a qualitative assessment to determine whether it is more likely than not (a likelihood of more than 50%) that an indefinite-lived intangible asset is impaired.

The ASU gives companies the option to consider relevant events and circumstances that may affect the fair value of an indefinite-lived i t ibl t C i ill d t id h th d ifintangible asset. Companies will need to consider whether and, if so, how much those events and circumstances could have affected the significant inputs they use to determine the fair value of the assetsassets

ASU 2012-021

Effective date - The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after 15 September 2012. Early adoption is permitted, even by companies whose impairment testing dates have passed if they have not yet issued their most recent financial statements or made them available for issuance.

Speaker BiographyJames Comito CPAJames Comito, CPA

Shareholder

Mayer Hoffman McCann P.C.

858.795.2029

[email protected]

A member of the MHM Professional Standards Group, James has an expertise in all aspects of revenue recognition, business combinations, impairment of goodwill and other intangible assets, accounting for stock-based compensation, accounting for equity

d d bt i t t d th ti iand debt instruments and other accounting issues.

Additionally, he has significant experience with a variety of other regulatory and corporate governance issues pertaining to publicly traded companies, including all p g p g p y p gaspects of internal control. In addition, James frequently speaks on accounting and auditing matters at various events for MHM.

Speaker BiographyKeith Peterka CPAKeith Peterka, CPA

Shareholder

Mayer Hoffman McCann P.C.

610.862.2744

[email protected]

With more than 19 years of experience in public accounting, Keith performs national firm responsibilities for IFRS, fair value accounting and auditing, revenue recognition and business combinations. He has also developed national training programs for accounting

t d l ti t ipronouncements and complex accounting topics.

Keith is a subject matter expert for IFRS, SEC reporting and fair value accounting in MHM’s Professional Standards Group. He also is a member on the IFRS Foundation's pSmall & Medium-sized Entities (SMEs) Implementation Group.

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MHM Executive Education Series Webinar: Valuation … EES... · Valuation Issues in Financial...

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