March 13, 2013 | Issue #126-2  

Fair value measurement causing new ‘uproar’ in ESOP community

Nearly two years ago, the Financial Accounting Standards Board issued Accounting Standards Update Fair Value Measurement (Topic 820, formerly FAS 157), requiring new disclosures with respect to the fair value determination for nontraded securities. The ASU became effective for nonpublic entities beginning in December 2011 and thus will impact ESOPs (those with December 2012 year-end plans) in the coming year.

As its ramifications became more widely understood, the ASU “has caused an uproar in the ESOP community,” according to the ASA’s weekly E-Letter to members. As editor Arlene Ashcraft explains, the new ASU requires companies to disclose any “significant” assumptions and methodologies used in the valuation of non-publicly traded company securities. The disclosure would appear in a footnote to the ESOP audit report, filed with Form 5500 at the DOL website (and many others) and would enable readers to assess the valuation techniques and inputs. “What level of detail this would require is still unclear,” Ashcraft says, “but may include what types of approaches were used (income, market, asset),” as well as other details that could potentially disclose “a large amount of information” on how the fair market value of the ESOP’s stock was determined as well as the fair market value of the sponsoring company. 

“This is not welcome news to private ESOP companies,” Ashcraft says. Last month, several stakeholders in the ESOP community—including the National Center for Employee Ownership (NCEO), the ESOP Association, and the Employee-Owned S Corporations of America (ESCA)—submitted a letter to the FASB’s technical director voicing concern over the ASU requirements and their consequences on employee-owned companies:

These disclosures would provide the public with information regarding private ESOP companies that otherwise would not be available. Collectively, these disclosures could allow readers to recreate a financial picture of the company. As you can imagine, in the hands of competitors, customers, and suppliers, this information could be damaging to the company and ultimately its employee-owners. Even more threatening may be the ability of corporate raiders to precisely ascertain the financial condition of otherwise private companies, enabling them to launch takeovers which ultimately work to the detriment of employee-owners who could lose the opportunity to own their companies. We are also concerned about other unforeseen negative consequences as a result of making such information publicly available. Ultimately, we believe it is important to keep this type of information as it relates to private ESOP companies just that—private.

“FASB has yet to respond,” Ashcraft says. “In the meantime, get ready for questions from your ESOP clients about this disclosure requirement.”

ASB adopts changes to USPAP 2014-15, but ‘backs off’ any ‘radical’ redefinition of report

Last month—after “careful consideration” and review of all stakeholder comments and opinions—the Appraisal Standards Board adopted changes to the Uniform Standards for Professional Appraisal Practice for the 2014-15 edition. Just recently, the ASB followed up with a Summary of Actions related to the proposed changes and providing the rationale for its ultimate conclusions.

For example, the board decided to adopt the proposed revisions related to the definition of “assignment results.” The adopted edits “clarify that assignment results include opinions or conclusions” and are not “specifically limited to the value conclusion in an appraisal assignment, or to the final opinion of the quality of another appraiser’s work in an appraisal review assignment,” the summary explains.

Similarly, the board adopted changes to the “scope of work” definition. Whereas “the SCOPE OF WORK RULE only applies to appraisal and appraisal review assignments,” the summary says, with emphasis, “the term scope of work is broadly defined to include all assignments performed under appraisal practice.”

Importantly, the board decided not to adopt any changes to the definition of “report,” pending further investigation and review. As the summary explains, with an implicit nod to business appraisers and the comments by their professional groups, including the ASA:

As a result of the concerns expressed with both the current and the proposed definitions of report, and the fact that these concerns are largely a function of the appraiser’s type of practice, the ASB has decided to investigate the possibility of having different report and workfile requirements based on the intended use and intended users of the assignment. The Board recognizes that this would be a radical change to USPAP and would affect many stakeholders. For that reason, such a change must be thoroughly investigated and vetted. Rather than rush to adopt changes for the 2014-15 edition, the ASB plans to follow-up on this issue after 2014-15 USPAP has been published. This will allow the Board to proceed judiciously and allow for the necessary level of consideration and deliberation on this important topic.

In the meantime, the board has also released an exposure draft of proposed changes to Advisory Order 21 related to its “retirement” of Standards 4 and 5 in the forthcoming USPAP, and also its explanation and opinion, complete with revised illustrative examples, of when USPAP applies to an appraiser’s practice. Comments are due March 25, 2013.

It’s not the DCF’s fault that BV is getting a beating in the courts

“The majority of all valuation tools, including the DCF, income approach method, require ‘sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed,’” says Paul French (Lain Faulkner & Co.), with emphasis, citing the AICPA Rules of Professional Conduct. The rules also require applying the relevant tool in a way that comports with generally accepted valuation methods and “unbiased” professional judgment, he says, adding to the ongoing discussion of BV in bankruptcy and other federal court decisions.

Failure to do so—on the record—is “the fault of the valuation analyst,” French believes, or the attorney who “fails to introduce the necessary evidence, ask the necessary questions during the valuation analyst’s direct testimony and/or the opposing expert’s cross examination.” If the record does not provide such comprehensive testimony by the valuation expert—including the financial projections, calculations, and conclusions, supported by unbiased testimony—and a thoroughly documented challenge of the opposing expert’s testimony along the same lines, the appellate court might not have any choice but to rely on the nonexpert evidence underlying the initial decision.

The valuation tools “are not at fault,” French says, another good reminder that preparation and professional standards are among the best “tools” available to a BV expert.

IRS came ‘this close’ to consensus on tax affecting

Not too long ago, a team of IRS engineering managers, BV specialists, and attorneys came together and developed a single approach for valuing S corporations. The team—headed Michael Gregory, a former IRS territory manager—submitted its approach for broader management review, with an eye toward taking it public.

The four territory managers and employees in the IRS’s engineering program “reached a consensus on how we might approach subchapter S issues,” Gregory revealed in his recent webinar on how to prepare a DLOM for the IRS. “However, over on the estate and gift tax side,” he said, there were five territory managers who couldn’t agree on a single approach. Some believed the six court decisions on tax affecting have resolved the issue as a matter of law and would compel the agency to appeal any case in which the valuator has tax affected. Other managers believed that it still is a factual issue, and some cases will call for tax affecting, but others won’t.

Still other territory managers wanted to submit each tax-affecting valuation to an individual review. Given the disagreement among IRS managers and executives, “there was no consensus” and no collective “desire to spend the political capital internally,” said Gregory, now a private consultant (Michael Gregory Consulting). The IRS continues to work on the issue—as will the BV community.

Testify strong: new guide to BV professional standards for attorneys

Pointing to Lance Armstrong’s plunge from the pinnacle of his profession and the millions of dollars in damage to his “live strong” reputation—all for failing to adhere to the standards of his sport—Mark Gottlieb (MSG) has posted a new white paper: “Attorneys’ Guide to Understanding Business Valuation Standards.”

“Working with a credentialed business valuation analyst that adheres to [professional] standards is important to both attorneys and their clients,” Gottlieb says. “Attorneys need to be familiar with these standards so that they can illustrate the credibility of their expert, or better understand the possible deficiencies of opposing professional opinions.” To download a copy of his white paper, click here.

IFRS 2013 ‘Red Book’ just posted

Yesterday, the International Accounting Standards Board and the IFRS Foundation released the 2013 International Financial Reporting Standards—also known as the “Red Book.”

The new, two-volume edition includes the official consolidated text of IASB pronouncements as of Jan. 1, 2013, and all IFRS with an effective date after Jan. 1, 2013 (but not the standards that they will replace). The Red Book is available in PDF format or a “bundled” print and PDF edition; for more information, check out the IFRS Foundation web shop.

Get your CPE before the busy season begins

We’ll be busy with three important webinar offerings this month:

  • Tomorrow, March 13, don’t miss Marc Bello (Edelstein & Co.) for Bernier: History, Impact, and Implementation and a discussion of how a “landmark” case on tax affecting is affecting the valuation of S corporations, determination of discounts, standards of value, and other key BV questions.

  • On March 21, tune in for Valuing Brands, when Mike Pellegrino (Pellegrino & Associates) and Ira Mayer (EPM Communications) examine how to assess and quantify what can be a firm’s most valuable asset: its identity and impact in the consumer marketplace.

  • On March 26, our ongoing 2013 Online Symposium on Healthcare Valuation continues with Part 3: Valuation of Home Health Service Providers, featuring Alan Simons and Gary Massey (both CliftonLarsonAllen), highlighting the industry, regulatory, and economic risks affecting the valuation of these increasingly prevalent entities.


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Copyright © 2013 by Business Valuation Resources, LLC
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