Death of financial statements may be exaggerated

A front-page article in a recent Wall Street Journal (May 12, 2007) reporting the possible demise of the familiar financial statement—at least the form that’s endured since the Industrial Revolution—may have been a bit premature.

The potential “overhaul” referred to in the article, which could produce “drastic” and “radical” changes to the way companies report financial performance (and investors judge financial opportunities)—including the elimination of “net income” as the “bottom line” indicator—is none other than the joint project by the FASB’s and IASB, Financial Statement Presentation, which has been in the works for over five years.

Although the Boards plan to unveil a Preliminary View by the year's end, that hardly amounts to a sudden “shock” that WSJ reporter David Reilly claims will “force every accounting textbook to be rewritten and anyone who uses accounting—from clerks to chief executives—to relearn how to compile and analyze information that shows what is happening in a business.” 

More likely, the project will continue to develop as the Boards gather feedback from the financial community and advisors such as the Joint International Group (JIG), formed in 2005, which advocates moderation.  “We must design the best reporting model for shareholders given the accounting model we have in place,” said member Ken Kelly (McCormick & Co.), in a JIG presentation on net income.  Fellow member Bo Eriksson (Stora Enso Oyj) agreed:

The future direction for performance reporting needs to be a mixed model that makes it possible to meet the requirements of…income as a measure of performance and as a measure of value creation.

To see what a future financial statement might look like, the WSJ has posted a hand-out from a FASB “advisory group” meeting last March (and notes that any change will only take place after “extensive due process and deliberation”).  Click here.

Four auditors—three different views on tax-affecting

Do the “Big Four” accounting firms accept tax-affecting when using the cost approach?  That question was lobbied at panelists during the recent “Current Topics in Business Valuation” conference at the New York City ASA.  Consider the responses:

  • Peter Wollmeringer (KPMG) said his firm wants all values to be after tax. 
  • Arthur Miller (Ernst & Young) and Stamos Nicholas (Deloitte) both said their firms would not accept tax-affecting. 
  • Matthew Pinson (PricewaterhouseCoopers) took the middle ground:  “We prefer tax-affecting, but given the controversy, we’ll accept either method” with a well-supported argument.

The wide range of responses reminds appraisers how important it is to discuss all aspects of a valuation for financial reporting with the auditor—not only the methods but the meaning of terms and the supporting analysis.

Tax-affecting in 20 minutes

It takes Nancy Fannon (Fannon Valuation Group) only twenty minutes and nine Power Point slides to explain her simplified model for tax affecting, which she accomplished at last week’s BV Conference at the Illinois CPA Society.  But, “What’s incredible and discouraging is that I’ve been teaching this stuff for five years,” she said, “and there’s still a general perception that the four models [for S Corp valuations] are complex and they are all saying different things.”

Fannon has effectively stripped down and synthesized the four traditional models (by Treharne, Van Vleet, Grabowski, and Mercer) to create her own, what conference presenter Jim Hitchner calls the “best of” model—and what Fannon simply calls the Simplified Model, soon to be published in a comprehensive guide on S Corp valuations from BVResources.  (Watch for it this summer.)  In the meantime, look for Fannon’s slides, articles, and more on the Simplified Model at her website.

Appraisers get passionate about FASB oversight

The answer was a clear if not clamorous “no” to last week’s online survey asking, “Should the FASB regulate the valuation profession with respect to financial accounting?”   (In fact, in the comment section, one respondent asked, “Is there a ‘Hell No’ button?”)  Nearly 85% of respondents want the FASB to steer clear from setting valuation standards.

“The notion that the appraisal profession cannot regulate itself and develop standards for valuation in the context of fair value accounting is…just flat wrong,” commented Eric Nath, ASA:

There should be no problem whatever getting this done through the Appraisal Foundation much more effectively and much more quickly than the FASB could ever hope to accomplish.  Regulations and/or standards on valuation from the FASB will also likely have some very negative unintended consequences both for the FASB [and for] the appraisal profession.

“The FASB is out of touch with the real world,” said another respondent. “They are creating rules that are nearly impossible to follow and are definitely cost prohibitive.”  Yet one more said, “It’s what they do.”

Given the outpouring of opinion, we’ve decided to extend the survey another week; to register your viewpoint, click here.  We’ll compile all responses and comments in an upcoming issue of the Business Valuation Update™.

Duff & Phelps data elevated to same level as Ibbotson’s

“We just last week elevated Duff & Phelps to equal status with Ibbotson’s” said Jim Hitchner at the Illinois CPA Society meeting in Chicago.  “I resisted this,” he added, referring to the time it took to study and synthesize the D&P Risk Premium Report data.  But with its eight size categories and other features, “it has a lot more flexibility than Ibbotson” (now published by Morningstar).  

“I’m not ready to give up Ibbotson,” Hitchner added, “but I predict that Duff & Phelps will be on equal status in the next few years.”  To purchase the 2007 Risk Premium Report as well as historic editions, click here.  And note: Beginning with the June 2007 issue, the BVU will start running Duff & Phelps data in its “Cost of Capital” corner—featuring four different size measures—right alongside Ibbotson data.  For a preview, click here.

Want to help clients increase company value 19%?

Just tell them to hire a top auditor.  Recent research by Gus DeFranco and others from the Universities of Toronto and Negev reveals evidence that “enterprise values of private firms who have a Big 4 auditor are 19% to 25% higher than firms without a Big 4 auditor.” 

These and additional findings—including how valuation multiples are “increasing in factors that proxy for earnings quality (e.g., Big 4 auditor) as well as a proxy for liquidity (working capital)”—are fully explored and explained in the academic’s working paper, “The Private Company Discount and Earnings Quality” available at the Social Science Research Network.  Click here to view the abstract; the site offers several download options, available at the bottom of the page.

The five questions judges will ask a lost profits expert

A recent article, “Proving Lost Profits After Daubert: Five Questions Every Court Should Ask Before Admitting Expert Testimony” (Univ. Richmond Law Review, Jan. 2007), distinguishes between experts who offer “honest and accurate” lost profits testimony—and those who push the “envelope of the extreme.”

The article offers a comprehensive survey of current lost profits conclusions under the Daubert standard, noting the unlikely cases (libel, for example) where CPAs and credentialed business analysts have been permitted to testify—and where they haven’t:

In spite of the fact that many CPAs have qualified as business appraisers or lost profits analysts, the mere fact that a person has years of experience as a CPA does not automatically qualify them as an expert to predict future profits or value a business.

The overall goal of the article: to suggest a remedy for the “serious flaws” in the current system of expert selection.  If lawyers and appraisers “understand that experts who take unreasonable positions will have their testimony excluded,” these attorneys and experts will more often conform to the current standards.  For a copy of the article, click here.

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