A mix of stakeholders participated in a full-day roundtable discussion at FASB headquarters in Norwalk, Conn., on November 15. The topic: the FASB’s Invitation to Comment (ITC) on moving from the current impairment model for goodwill to one of amortization or a hybrid approach. Other issues included whether other intangible assets should be subsumed into goodwill and whether there should be more disclosures about goodwill and intangible assets.

The valuation profession was well represented at the roundtable—and so were users of financial information (including investors), practitioners, preparers, academics, standard-setters, and regulators. Members of the valuation profession have serious concerns over going back to a model that treats goodwill as a wasting asset. Here are some key points that were made during the morning session of the roundtable:

• Most users support impairment—there is definitely “news” in an impairment charge. That is, it is not solely a lagging indicator of company performance (academic studies support this), so the impairment process is “overwhelmingly” useful as a signal of what’s to come.

• The acquisition of a business assumes a going-concern premise, so the concept of goodwill amortization is not compatible with this premise.

• In practice, an acquired firm and its goodwill get integrated into an operating or reporting unit and it becomes nearly impossible to track goodwill back to the specific acquisition in order to evaluate performance. Added disclosures about future impairment charges should talk about the reason—whether it’s because of the acquisition or the legacy operations.

• The higher up you go in terms of the level at which you test goodwill, the less meaningful it becomes. Testing at the entity level (versus an operating-unit level) could mask poor performance at lower levels.

• Goodwill has different elements, some which may be wasting but others may not be (such as synergies, as one commenter pointed out—but that’s debatable). Different companies can have very different goodwill elements of variable magnitudes. Some commenters are inclined to let management decide the useful lives of the components, while others disagree because you’ll get a wide disparity in lives.

• Increased disclosures will be helpful (such as what the primary intangible asset was that the acquirer wanted), but there’s a concern about information overload.

• If a default useful life is used with amortization, it should be set at a minimum of 10 years and allow for management judgment (with disclosure) and also triggering events. A commenter from Japan said they use a combination of amortization and impairment and most companies choose 10 years or less for useful lives (20 years is the max).

• There is a general agreement that it is important for global standards (IFRS) to converge. The IASB is also exploring whether to amend its approach to accounting for goodwill, but it is divided about the benefits of reintroducing goodwill amortization to IFRS standards. The IASB plans to release a Discussion Paper in early 2020 for a 180-day comment period to weigh stakeholder interest in amending IFRS 3, Business Combinations and IAS 36, Impairment of Assets.

• Speaking of convergence, commenters from the M&A world had different experiences about the impact of accounting rules on deals. One said that, at the margin, different accounting rules may scuttle a deal. When using an EPS model, acquirers will pay more when impairment is used versus amortization (academic research backs this up). But another commenter said that, in his 20 years of M&A experience, he never saw that happen.

• In response to a concern about what methodologies valuation experts use in valuing intangibles, it was stressed that there is a “very robust” body of knowledge and standards that all experts follow, such as The Appraisal Foundation’s financial reporting valuation advisories and AICPA guides, such as the upcoming guide on business combinations.

The afternoon session of the roundtable had the same mix of stakeholders, but the individual players changed. We’ll have coverage of that session in the next issue of BVWire.

What’s next: The FASB has done an excellent job of laying out the issues and soliciting comments from a wide variety of stakeholders. But this is just the first step. Next, the comments will be processed, and a presentation will be made to the FASB board, which will decide on what action to take. Typically, an exposure draft would be issued and go through one or more revisions before rules are finalized. This entire process can take up to several years to complete.

Parties fight over notes-containing expert report: draft or final version?

Several sessions at the recent AICPA conference in Las Vegas highlighted the importance of expert discovery in litigation and noted that draft reports continue to be a hot-button issue. A recent contract dispute, litigated in federal court, in which the defendant tried to exclude the opposing expert for violating federal expert disclosure requirements is a case in point.

The plaintiff, Maricopa County, Ariz. (Maricopa), sued Office Depot, alleging the defendant had breached a pricing commitment Office Depot had made to certain state and local public agencies. Both parties presented expert testimony and tried to exclude the rivaling experts (Maricopa retained two experts) under Rule 702/Daubert. Moreover, Office Depot claimed one of the plaintiff’s experts was precluded from testifying because the plaintiff violated Rule 37 of the federal rules of civil procedure, which specifies sanctions for failure to make disclosures or cooperate in discovery, including prohibiting the expert from testifying “unless the failure was substantially justified or is harmless.”

Little guidance on what’s a draft: At his deposition, the expert said that the report he had sent to the plaintiff had a spreadsheet attached that had an extra column titled “Notes,” in which he “listed out [his] thinking and questions” regarding certain items he was asked to examine. Asked whether the “Notes” column was included in his final report, he said, “I believe so.” The plaintiff did not provide the “Notes” column in the final version of the report that went to the defendant. In its motion, Office Depot claimed the plaintiff altered the report and deprived Office Depot, the court, and the jury access to the expert’s “true opinions.” Rule 26(a)(2)(B)(i) requires that an expert report include “a complete statement of all opinions the witness will express and the basis and reasons for them.”

According to the plaintiff, the notes-containing version of the expert report was a draft and was not discoverable. Rule 26 protects as work product “drafts of any report or disclosure required under Rule 26(a)(2), regardless of the form in which the draft is recorded.”

The key issue was whether the notes-containing version of the report was a draft. “The case law, somewhat surprisingly, provides little guidance when it comes to determining whether an expert’s report was a draft or final version,” the court said. It concluded the report the plaintiff produced to Office Depot was a complete statement of the opinions the expert would express, including the reasons for his opinions. The earlier notes-containing version was a draft. The court noted that this expert did not have much experience as an expert and “it would be unusual for a final report to contain this sort of raw information.” It said Office Depot did not take issue with the “reasoning and explanation provided in the report” but simply argued it should have received the version the expert originally sent to the plaintiff. “This bolsters the conclusion that the analysis contained in the final, produced version constituted a complete expression of [the expert’s] opinions.”

Be careful: Many, but not all, states have procedural rules that align with the federal rules of expert discovery. It is critical that experts are familiar with the rules applicable in the jurisdiction in which they practice.

A digest of County of Maricopa v. Office Depot Inc., 2019 U.S. Dist. LEXIS 175695 (Oct. 9, 2019), and the court’s opinion are available to BVLaw subscribers now.

EY study examines TCJA impact on S corps

The Tax Cuts and Jobs Act (TCJA) succeeded in maintaining rough tax parity between large pass-through businesses and large C corps but only if the 20% qualified business income (QBI) deduction is in effect and only if it’s made permanent, according to an EY study commissioned by the S Corporation Association. In terms of both effective and marginal tax rates, the analysis shows that, prior to the TCJA, large S corps and C corps faced similar tax rates and this parity remained following the enactment of the TJCA. However, the sector will face significantly higher tax rates in 2026 than C corps with the expiration of key TCJA provisions, such as the 20% Section 199A deduction for QBI. The study is titled “Large S Corporations and the Tax Cuts and Jobs Act: The Economic Footprint of the Pass-Through Sector and the Impact of the TCJA.”

GDP growth slowed in 3Q 2019 per Economic Outlook Update

The U.S. economy—as indicated by GDP—grew at an annual rate of 1.9% in the third quarter of 2019, which is slower than the downwardly revised rate of 2.0% reported for the second quarter of 2019, according to the 3Q 2019 Economic Outlook Update (EOU). Despite the dip in the third quarter, the 1.9% growth beat forecasts of 1.6% growth, according to a survey by Dow Jones. Here are a few other highlights from the report:

• The Leading Economic Index declined 0.1% in September, to 111.9 points, which follows a decline of 0.2% in August;

• Total government spending grew 2.0% in the third quarter, which is less than the rate in the prior quarter, when it grew 4.8%;

• The Consumer Confidence Index decreased 9.1 points in September, to 125.1, due to rising trade tensions with China; this was the largest one-month decline since December 2018;

• Job growth is slowing as the labor markets near full employment; and

• Small-business owners continue to feel confident about the economy and the future of their businesses; 58% say their revenues increased over the past 12 months, which is up 6.0 percentage points.

The 53-page 3Q 2019 Economic Outlook Update (EOU contains expansive research from leading authoritative resources, which you can use in your valuation reports as long as you give proper attribution. The EOU is published monthly and quarterly.

Auditors to increase focus on quality of work of valuation experts

In its new standard concerning the use of specialists, the Public Company Accounting Oversight Board (PCAOB) wants auditors to move away from a checklist mentality and use more professional judgment. Wendy Stevens, a member of the board’s Standing Advisory Group, says the PCAOB doesn’t want rote procedure; it wants quality. The auditor must still consider factors such as the objectivity and expertise of the expert, but the new standard includes things such as laying out the specific requirements for when an auditor can engage an outside expert; procedures to evaluate a company specialist’s use of data, significant assumptions, and methods; as well as the reliability of the specialist’s work and its relationship to the relevant assertion. Although the standard goes into effect at the end of next year, she warned that implementation should begin as soon as possible because it will probably take time to fully put it into practice. Stevens made her remarks at the Foundation for Accounting Education’s November 14 Auditing Standards Conference.

A simple look at betas—and other inputs to the income approach

When estimating a company’s cost of equity, we all know investors adjust for varying levels of risk. Whether you’re using the modified CAPM or the buildup method, significant differences in the proportional amount of financial leverage will have a significant impact on risk and therefore the cost of the equity. “We appraisers have relevering beta formulas at our disposal for this risk adjustment but understanding the formulas and their implementation can be challenging,” says Bob Dohmeyer (Dohmeyer Valuation Corp.). Challenging indeed! At a recent conference session that we attended, the audience had great difficulty grasping the notion of levering, unlevering—and then relevering—the cost of capital. Dohmeyer will be part of a panel that will take a fresh look at the income approach—from top to bottom—including the use of betas. “We’ll be discussing the simplest relevering beta formula and showing that it’s actually more simple and intuitive than it looks,” he says.

The panel will conduct a special four-hour online workshop November 21 titled Back to the Future? Exploding the Income Approach. The other panel members will be Bethany Hearn (CliftonLarsonAllen LLP), Brenda M. Clarke (Seigneur Gustafson LLP), and Kevin R. Yeanoplos (Brueggeman and Johnson Yeanoplos PC). The workshop will be divided into two parts: a discussion of current hot issues in the numerator (forecasting, free cash flow, and adjustments) and then an examination of the denominator (beta, equity risk premium, and company-specific risk). It will be part lecture and part debate, but totally relevant and practical.

Registration open for workshop on valuing
FLPs and LLCs

BVR is pleased to announce a special four-hour web workshop, A Masterclass in the Valuation of Family Limited Partnerships and LLCs, on December 5, featuring leading experts on the topic, Bruce Johnson and Jim Park (Munroe, Park & Johnson Inc.) and Spencer Jeffries (Partnership Profiles). They will present case studies on valuing noncontrolling, nonmarketable FLP and LLC interests that hold real estate, marketable securities, and mixed assets. They will also discuss where to get objective data to support discounts for lack of control and lack of marketability. Speaking of data, BVR now offers two sources of closed-end fund data commonly used to derive discounts for lack of control for FLPs and LLCs:

• “2019 Closed-End Fund Report: Fixed Income Securities.” Use this report to compare privately held family limited partnerships (FLPs) and LLCs that hold money market funds, certificates of deposit, government bonds, municipal bonds, corporate bonds, or other fixed income investments; and
  
  
• “2019 Closed-End Fund Report: Stocks and Equity Investments.” Use this report to compare privately held FLPs that hold common stock, preferred stock, mutual funds, REITs, or other corporate equity investments.

As the FASB is doing in the U.S., the International Accounting Standards Board is also exploring whether to reintroduce goodwill amortization. The IASB plans to release a Discussion Paper in early 2020 (February, we hear) for a 180-day comment period to weigh stakeholder interest in amending IFRS 3, Business Combinations and IAS 36, Impairment of Assets.

In conjunction with a recent meeting of the trustees of the IFRS Foundation in New York City, a stakeholder event was held that was jointly organized with the CFA Institute. During that event, the IASB explained that it hopes the feedback on the Discussion Paper will help it arrive at a consensus, according to a report on the event. “Some board members support a reintroduction of goodwill amortization because they believe the existing impairment model is not providing information to the markets on a timely basis,” the report says. “Other board members want to leave the impairment model intact because they believe the model, even with its limitations, still gives investors useful information that holds management accountable for its decisions about acquisitions.”

“There should be an expense somewhere,” said Hans Hoogervorst, IASB chair. “We see time and again that goodwill only gets written off when it’s too late.” Hoogervorst acknowledged that the board’s challenge is to provide investors with the information about acquisitions that they need. Therefore, the board’s project will not only deal with goodwill and how it is treated, but it will also focus on possible new disclosures to help investors assess the subsequent performance of an acquisition.

Here’s what you’ll see:

• “New Meta-Analysis Study Reveals Diminished Size Premium” (BVR Editor). There have been many studies on the size premium but with conflicting results. Now, the first “meta-analysis” of the size premium provides an estimate that is smaller than what many people believe, according to a new paper.

• “Valuing a Financial Advisor’s Book of Business” (Howard A. Buchler, J.D.). A court may not immediately recognize the value of a financial advisor’s collection of client relationships. The author illustrates this based on a case in which he was one of the testifying experts, and he also discusses various perspectives on the valuation.

• “Using Industry Benchmarks to Establish Secure Negotiating Positions for M&A Purposes” (Casey Karlsen and Seth Webber, BerryDunn). M&A parties are often at odds with the valuation, causing many deals to ultimately fall apart. One solution to this dilemma is to select a multiple based on how the subject company compares to industry benchmarks. The authors include a discussion of a new resource: The Valuation Benchmarking Platform.

• “Musings on the Cost of Capital” (Ronald L. Seigneur, Seigneur Gustafson LLP). A veteran appraiser presents an interesting retrospective on the cost of capital and offers some observations on current practice.

• “Latest Resources to Help Improve the Valuation of Financial Instruments” (BVR Editor). Recent resources that have emerged, including some new credentialing, that are designed to improve this area of practice are reviewed. This is the valuation profession’s response to the concerns of financial regulators and others around the world about the quality and consistency of financial instrument valuations.

• “Reports From Global BV Conferences: ICVPME, IVSC, IACVS, ICAEW” (BVR Editor). The “I” in all of these acronyms stands for “international,” and Business Valuation Update brings you some key takeaways from several recent global conferences.

The issue also includes:

• An expanded section of “BV News and Trends/Global BV News and Trends.”

• Regular features: “Ask the Experts” and “Tip of the Month.”

• BV data spotlight: “DealStats MVIC/Revenue Trends,” “ktMINE Royalty Rate Data,” “Economic Outlook for the Month,” and the “Cost of Capital Center.”

• BVLaw Case Update: The latest court cases that involve business valuation issues.

To stay current on business valuation, check out the December issue of Business Valuation Update.

BV movers ...

People: Heidi Walker, CPA/ABV, ASA, is now with GreatBanc Trust Co. as senior vice president, financial analyst in the Employee Stock Ownership Plans (ESOP) Client Services group; she formerly served as managing director of the ESOP Advisory Practice for Marcum LLP … Andrew Probert has joined Duff & Phelps as a managing director in the Transaction Advisory Services (TAS) practice, based in London; he was formerly with Ernst & Young, where he focused on designing optimal deal structures … Olivia Kirtley, former chair of the American Institute of CPAs and president of the International Federation of Accountants, has been named the first recipient of the ASWCPA Lifetime Achievement Award, which recognizes women who have demonstrated leadership and a strong record of accomplishment in furthering the advancement of women in the accounting profession.

Firms: Portland, Maine-based Baker Newman Noyes expands, with new offices in Woburn, Mass., to increase its presence in the Boston area; the firm will add 15 to 20 employees in the new office over the next 12 to 24 months … New York-based Marcum LLP received top rankings for valuation, forensics, and litigation support services in three leading regional legal journals: Connecticut Law Tribune, The Legal Intelligencer, and the New York Law Journal; the firm received nine top rankings in total, including three in first place, one of which was in the “Litigation Valuation Provider” category … Chicago-based BDO Alliance USA has added three new firms as members: Moody & O’Neal CPAs (Mount Pleasant, S.C.); Spoor Bunch Franz (St. Petersburg, Fla.); and Stockman Kast Ryan + Co. (Colorado Springs, Colo.); BDO Alliance USA now has 214 member firms in more than 500 locations nationwide … Two Miami firms, Ravan & Co. CPAs and Blanco + Co., have merged; the combined firm has 12 employees and will operate under the name Ravan + Blanco LLP … Canfield, Ohio-based Hill Barth & King (HBK) has announced that a subsidiary, HBK IT, has acquired Unicom Solutions Group of Mountainside, N.J., a technology consulting firm to small and midsize private companies, nonprofits, and government agencies.

Please send your professional and firm news to us at editor@bvresources.com.

Upcoming BVR training events

• Reasonable Certainty for New Business Lost Profit Calculations (November 20), with Josh Shilts (Villela & Shilts).
  
  A discussion of recent case law and various approaches to validate a lost profit projection for early-stage companies.
  
  

• Back to the Future? Exploding the Income Approach (A Four-Hour BVR Workshop) (November 21), with Robert M. Dohmeyer (Dohmeyer Valuation Corp.), Bethany Hearn (CliftonLarsonAllen LLP), Brenda M. Clarke (Seigneur Gustafson LLP), and Kevin R. Yeanoplos (Brueggeman and Johnson Yeanoplos PC).
  
  This four-hour workshop looks at hot issues in the valuation equation. The first half will focus on the numerator, with a curated selection of hot issues such as forecasting, free cash flow, and adjustments. The second half will dive into the denominator, with betas, equity risk premium, and company-specific risk premiums. It’s part discussion and part debate—but completely relevant and practical.

HOLIDAY BREAK
BVWire will be taking a break to enjoy the U.S. Thanksgiving holiday next week. We will resume publication on Wednesday, December 4. We wish you a very happy holiday!