Two new FASB releases

Last week the Financial Accounting Standards Board (FASB) issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities.  “The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows,” says the FASB release.  “The new standard also improves transparency about the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under Statement 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows.”   Effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, FAS 161 is available here.  Early application is encouraged. 

Last week the FASB also released Staff Position (FSP) No. 132(R)-a, Employers’ Disclosures about Postretirement Benefit Plan Assets.  “The purpose of the proposed FSP is to obtain feedback from constituents on proposed guidance intended to improve the quality of financial reporting by increasing disclosures about the types of assets held in postretirement benefit plans,” says this release.  The proposed amendments include: i) a principle for disclosing the fair value of categories of plan assets by type; ii) categories of plan assets that should be disclosed; iii) disclosures about nature/amount of risk within plan categories; and iv) disclosures about fair value measurements (similar to FAS 157 requirements).  Respondents have until May 2, 2008, to comment.  The disclosure requirements of FSP 132(R)-a would be applied on a prospective basis for fiscal years ending after December 15, 2008; for a copy, click here.

Fraud claims could freeze fair value ‘in its tracks’  

After the subprime meltdown and the recent run on Wall Street banks (see last week’s BVWire), two schools of comment seem to be developing—one that keeps pointing to the “folly” of fair value accounting, and the other that says the financial reporting system is responding precisely as it should.  The frustration of the former is “understandable,” says a new article by Michael Young, a corporate securities attorney with Wilkie Farr & Gallagher (New York City).  While the recent economic news hasn’t been pleasant, “one benefit to fair value accounting—and FAS 157 in particular—is that it has given outside investors real-time insight into market gyrations…that, under old accounting regimes, only insiders could see.”   But at least one feature of the subprime aftermath has the potential to be “completely counterproductive,” Young warns:

It is the extent to which our system of litigation and regulatory oversight results in unjustified assertions of ‘fraud’ against those who were doing their best under circumstances that were exceedingly difficult. … For the very aspects of fair value accounting that make it susceptible to second guessing—the absence of concrete data, the need for judgment, the importance of predictions—are likely to increasingly become more prominent features of financial reporting generally.

If our highly litigious systems do penalize auditors, financial administrators, and valuation analysts for “good faith” judgment calls gone bad—then “continued progress in financial reporting…will foreseeably be frozen in its tracks,” Young says in his article.  Young will join FASB Chair Bob Herz at a conference on the “Challenges Arising from Fair Value and Other New Accounting,” to be held in Manhattan on April 11, 2008 by the Directors Roundtable. Registration is free.

IRS tightens cost-sharing of stock options

“I.R.C. §482 consists of two sentences,” the Internal Revenue Service explains in a new Coordinated Issue Paper (CIP) issued March 20, 2008.  “The first sentence authorizes the Secretary to allocate income and deductions among commonly controlled organizations as necessary to clearly reflect the income of those organizations.”  The second sentence requires that—in the case when a U.S. company and foreign affiliate co-develop an intangible asset with certain benefits—they share the proportionate costs.  In the case of stock-based compensation (SBC), the Service generally measures this expense according to the “spread value” (difference between fair market value on exercise date and the option’s exercise price) or “grant date value” (applying FAS 123 fair value approach).

The problem: Cost-sharing regulations did not specifically include SBC until 2003.  In a case decided under the old (1995) regulations, Xilinx Inc. v. Comm’r 125 T.C. 37 (2005), the Tax Court held that the Service’s inclusion of SBC in the cost pool was “arbitrary and capricious,” because—on the basis of expert testimony—parties could make an arms-length arrangement not to share the spread or grant date value.  The Service has appealed the decision to the Ninth Circuit, according to the new CIP, and even if it loses, plans to apply the decision only to cases that come under the 1995 regulations.  “For cases under the 2003 SBC Regulations, such a decision would not be controlling.”  Moreover, the case would not control those outside of the Ninth Circuit. A copy of the Xilinx opinion is available here, and is now among the over 2,700 federal and state valuation cases available at BVLaw™ .

Over 6,000 transactions in Mergerstat/BVR database

There are currently 6,090 total transactions across 674 SIC codes in the Mergerstat®/BVR Control Premium Study™ database.  Half of the deals have net sales less than $100 million, while the remaining half post net sales greater than $100 million.  The top 25 SIC codes include over half of the transactions (3,360), and according to the most recent calculation (July 2007), there were 770 deals in business services, 690 deals in depository institutions and 195 in the communications industry.  Over 80% of the transactions are 100% acquisitions.

These were just some of the statistics that came out of last week’s webinar, “Getting the Most from the Mergerstat/BVR Control Premium Study,” featuring Shannon Pratt, Alina Niculita, Rob Stutz, and BVR financial analyst Adam Manson.  A live poll also uncovered another interesting statistic: Most attendees (41%) use the database primarily to calculate a minority discount, while a quarter (25.6%) use it for the control premium and 10.3% use it for the valuation multiples—a lesser-known application of the database, Dr. Pratt pointed out.  (The remainder of attendees never used the database or were not appraisers.)  The panelists use the database for every valuation—and Pratt has even used comparables that were 100 times the size of his subject company, because they were most similar to the subject.  To conduct your own searches, click here.
What database are analysts using?

In the webinar on “Transaction Databases” last week from Valuation Products and Services and the Financial Consulting Group, attendees took an informal poll to find out who used which databases (they could check off more than one).  The results:

The more transactions you have, the better, according to co-presenters Jim Hitchner and Sam Wessinger.  If you have just a few individual transactions and don’t know much about them, you may not want to use them in a primary valuation method but as corroborating evidence.  On the other hand, if you’re valuing a larger business, have good transactions, know a lot about them (typically from public company buyer source documents), and checked the information in SEC filings to calculate your own valuation multiples, then you should feel more comfortable using them as a primary valuation method.  And if you’re valuing a small business (using the DMDM method—Direct Market Data Method developed by the IBA) with enough transactions in a pool to develop a market, then pick a multiple in the spectrum and use this as a primary method.

Liquidity discounts becoming more recognized 

“Liquidity has the potential to be a more important factor in determining financial market prices than even risk and return,” according to Prof. Francis Longstaff, who joined Prof. Ashok Abbott, Marc Vianello, and moderator Ron Seigneur in what capped a week of webinars, this one on “Exploring the Longstaff Model and Abbott Liquidity Factor for Enhanced Marketability Discount Determinations” by the AICPA’s FVS Section.  Polling continued apace, with a clear majority (64%) of listeners acknowledging the difference between a discount for lack of liquidity and a discount for lack of marketability (DLOM).   Vianello advocated the Longstaff methodology, which calculates the upper bound of the cost of liquidity restrictions based on recognized methods of pricing options contracts.  It yields an objective DLOM estimate for each valuation engagement by using guideline price volatility and the projected time between the valuation date and the company sale.  When applying these theories, however, Abbott emphasized that “one size does not fit all.”   Blanket approaches using historical averages are not sustainable, and—like so many applications in business valuation—the appraiser must perform case-specific analysis, dependent on the facts and circumstances. 

Another live survey question: How much weight do you give to restricted stock and pre-IPO studies in estimating the discount for lack of marketability for a privately-held company?  Nearly a quarter of listeners (22%) replied they weight these studies less than 25%, while just about the same number (21%) weighted them between 25 and 50%.  Over a third (37%) of respondents weighted them between 50 and 75% and a fifth (20%) gave them a weight greater than 75%. 

To learn more about the Abbott Liquidity Factor, read “New Abbott Analysis Aids Valuators in Assessing Liquidity Discounts” at BVR’s Free Downloads page, or click here to request more specialized information. The FMV Restricted Stock Study™ is available here and the Valuation Advisors’ Lack of Marketability Discount Study™ (a pre-IPO study), here.

IASB issues paper on reducing complexity

Last week the International Accounting Standards Board (IASB) published its discussion paper, Reducing Complexity in Reporting Instruments.  “The existing requirements for the reporting of financial instruments are widely regarded as difficult to understand, interpret, and apply,” the announcement says, “and constituents have urged the IASB to develop standards that are principle-based and less complex.”  The document is the first stage in a project that aims to replace IAS 39 Financial Instruments: Recognition and Measurement; it analyzes the main causes of complexity in reporting financial instruments and proposes possible intermediate approaches to address some of them.   “The IASB seeks views on both the possible long-term and intermediate approaches, and…how it should proceed in developing new standards for reporting financial instruments that are principle-based and less complex.”  Comments are welcome through September 19, 2008—and the FASB may also publish the paper for feedback from its constituents.  To review the discussion paper, click here.

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