FASB releases 141R

Last Friday the Financial Accounting Standards Board (FASB) released the long-awaited Statement No. 141 (revised 2007), Business Combinations.  “The objective of this Statement is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects,” according to the Summary.  The revised Statement establishes principles and requirements for how the acquirer:

1. Recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.
2. Recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase.
3. Determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination.

Replacing Statement No. 141 (2001), SFAS 141R also supersedes FIN No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method, and amends SFAS No. 109, Accounting for Income Taxes.  It amends SFAS 142, Goodwill and Other Intangible Assets, “to, among other things, provide guidance on the impairment testing of acquired research and development intangible assets and assets that the acquirer intends not to use.”   Application is prospective to business combinations “for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.” To read the full Statement No. 141R, click here.

FASB asks for ‘light’ (not heat) from BV

Following up his comments in last week’s BVWire™, Michael Mard offered his unique perspective as a member of the FASB’s Valuation Resource Group (VRG) on the critical and continuing dynamic between the Board and the BV profession.  “The VRG reports to the staff of the FASB,” he explains.  “We identify and address (pros and cons) interpretation issues on SFAS 157, with emphasis on those assets and liabilities creating the most diversity in reporting earnings per share (EPS).”   The FASB and the VRG seek communication in all forms.  “VRG is an orderly group trying to digest and report (to the Staff) input from the valuation community.  We welcome input leading to ‘consistency’ and ‘transparency,’ though Bob Herz (FASB chair) has said ‘please send light, don’t send heat!’”

Mard also sheds light on the recent discussions surrounding the deferral of 157.  “Preparers (management) and auditors complained, perhaps understandably, about the difficulty to accurately comply with FV for financial instruments.  They didn’t want their rush to comply to create imprecision or diversity impacting EPS.”  On the other hand, “investors and users want this information now,” to the best of the preparers’ ability.  In the end, the FASB chose to serve the latter, and declined to defer 157 implementation pertaining to financial instruments.

This episode—as well as much of the controversy rising from fair value for financial reporting—might best be seen through the FASB’s overall mission, “to serve the investing public through transparent information resulting from high-quality financial reporting standards,” Mard says, “developed in an independent, private-sector, open, due process.”   In its reporting responsibility to the SEC and the U.S. Congress, the FASB believes the users of financial data, both bankers and direct investors, want more relevant ‘mark to market’ information presented on companies’ balance sheets, which historically captured only 30% of assets.  “So now the goal—and hopefully the result—of 157 will be to reflect most of the other 70%.”  The goal is also to accomplish this in a predictable and consistent way that minimizes diversity and earnings volatility.

“Unfortunately, this information is very difficult and expensive to develop for preparers of financials (companies) and even more difficult to audit consistently,” Mard says.  “The FASB, however, has been steadfast in believing the benefit of the information to the public is worth the cost of the information to the preparers.”  Mard’s comments and opinions are his own (and not those of the FASB or the VRG).  Look for more from Mard—on standard of value, hierarchy of value, effect of BV standards and other issues confronting the VRG—in an upcoming issue of Business Valuation Update™. 

Laro to BV: Get peer-reviewed before getting to court

“Permit me to be critical,” Judge David Laro (U.S. Tax Court) told the AICPA BV attendees last week, in the session that closed the New Orleans conference.  “I’m not trying to be harsh,” he said, prefacing his views on the “top ten mistakes” appraisers make in court (and how to prevent them).  “I just want to point out what you can do better.”   In taking direct questions from moderator Ron Seigneur and audience members, Laro’s “top ten” included:

• Be consistent.  “You don’t get different results whether you work for the taxpayer or the government.”
• Be independent.  “Candidly, if a conflict of interest comes to the attention of the court, it completely eradicates your credibility.”
• Be thorough.  BV reports are getting more complex, “and that’s good,” Laro says.  He wants to see less boilerplate and more “strength of analysis of the data.”
• Be thick-skinned.  Recent critiques of appraisers by federal tax and circuit courts may have gone too far—for example, it shouldn’t really matter what state the appraiser comes from (vis-à-vis the subject interest) or how long he/she remains on a site visit.  “What matters is what you do there.”
• Be independent.  Laro couldn’t stress this one enough.  “Don’t get influenced by the people who hire you.  That catches up with you real quick and that never succeeds.”
• Be peer-reviewed.  Don’t depend on the courts to do this for you.  “Frankly, the court is not your peer.  This organization is,” he said, “your colleagues are.  The court should not be put in the position of sanctioning or approving one method or another.  That’s for you to do.”

For all of the items on Laro’s long list—including his opinion on marketability discounts, the possibility of a Jelke appeal to the U.S. Supreme Court, BV standards and appraiser certifications—look for a full write-up in the next (January 2008) issue of the BVU.

DLOM for controlling interests: a ‘discount of convenience’?

When the 500 (or so) attendees at an AICPA BV panel discussion on discounts for lack of marketability (DLOM) were asked if they employ a marketability discount when valuing controlling interests, the vast majority—about 75%—raised their hands.  This prompted moderator Linda Trugman and panel members Chris Mercer, Ron Seigneur, and Mel Abraham to discuss—and unanimously agree—that doing so may be without conceptual basis. “It is the cash flows of a business which give rise to value today—and tomorrow and the next day, until it is ultimately sold,” Mercer says, responding to BVWire’s request for further explanation.  The controlling shareholders have full benefit of the cash flows until sale.  To establish a marketability discount for controlling interests, “there would have to be an unobservable value from which this nebulous discount is taken in real transactions,” Mercer says, “because the multiples that are observed in the marketplace are necessarily net of any and all discounts!”

Anyone who can provide a conceptual basis for this “popular” discount should do so, he adds, “else all those who use it have no basis for applying it,” Mercer says, “and it becomes a discount of convenience.”  Take his logic one step further: “No valuation concept (or discount or premium) has any meaning absent a conceptual basis for it.”  The conceptual basis for the value of an illiquid, minority investment, for example, is the present value of future cash flows, derived from the enterprise and received by the security holder, discounted to the present at an appropriate discount rate, for the expected holding period of the investment.

“And don’t forget,” Mercer notes, that since 2005, USPAP has required consideration of the “holding period, interim benefits, and the difficulty and cost of marketing” of the subject interest (see SR 9-4(d)).  Yet he was surprised to see how many AICPA BV attendees said they still apply averages of restricted stock studies or benchmarking analysis.  “These methods simply do not enable the appraiser to analyze the effect on value, if any, of differences in expected cash flow (from those of the enterprise), differences in expected growth, or differences in risks over relevant expected holding periods.”  Just about 10% to 15% of attendees indicated using Mercer’s QMDM.  “I think we’ll see that changing.  When we meet again at the next conference,” he predicts “the number of QMDM users—or users of shareholder-level DCF models—will be significantly higher.”  For more discussion, visit the extensive article library at Mercer Capital, including “Quantifying Marketability Discounts: Valuing Shareholder Cash Flows.” 

Fair value, IRS, discounts, S Corps, and more:
Your opinion on the most critical BV topic in 2007

In response to our annual, on-line survey about the most important BV issue of 2007, one respondent wrote in: “All of the above!”   Another implied that next year’s political contest might take a backseat to BV concerns:

BV standards will be the biggest problem. Our profession has turned into a dog-eat-dog world, when, in fact, we ought to be working toward commonality in standards. The AICPA is the late comer on the scene and now wants to be the BIG DOG.  Discounts have always been a problem and the more formula-driven our profession becomes (and it has), the more obvious the weakness in our frail argument when we try to pin down the discount number.  BV professionals have to understand that small business valuation is very much a different animal than large corporate valuations. The courts need to realize that minority and illiquid investments do require some discounting even though they are hard to quantify. There has to be some reason brought to our work. It's starting to look like the Gore/Bush debate all over again. Who wins this one is my question?

Preliminary results show that FASB issues are neck-and-neck with S Corps, receiving 23% and 26% of the vote, respectively.  Compare this to last year, when only 6% of respondents believed that fair value for financial reporting had the greatest impact in 2006, compared to 40% who thought tax affecting was the hottest topic, followed by 35% who voted for “all things IRS.”  So far this year, the IRS has registered about 19% of the vote. Your vote counts: To add your response and comments to this invaluable survey of the profession (it will take only a few seconds) click here.

PCAOB levies $1 million fine against D & T

This Monday the Public Company Accounting Oversight Board (PCAOB) issued orders instituting disciplinary proceedings against Deloitte & Touche LLP and a former Deloitte audit partner, for violations of the Board’s interim auditing standards in connection with the firm’s 2003 audit for a large pharmaceutical concern.  Without admitting or denying the Board’s findings, Deloitte consented to an order imposing a $1 million civil money penalty; it has also implemented changes to its internal policies and procedures for addressing potential audit quality concerns.  The orders require Deloitte to undertake certain documentation practices relating to these additional quality control policies and procedures, and the audit partner involved “has consented to an order barring him from being an associated person of a public accounting firm that is registered with the PCAOB."  The Board’s orders are available here.

The PCAOB has also just released a Staff Audit Practice Alert on the audit of fair value measurements in financial statements.  The alert provides auditors with information related to auditing fair value measurements and disclosures as well as the use of specialists in this area.  See Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists.