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Fasb 142

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The SFAS No. 142 Valuation Report

                                  Presentation for the
                          22nd Annual ASA Advanced
                                  Business Valuation
                        Chicago, October 16-18, 2003
                   Underlying Reasons
   The Financial Accounting Standards Board’s (“FASB”)
   Statement of Financial Accounting Standards (SFAS) No. 142
   stated the following reasons for development of these
   Standards: “Analysts and other users of financial statements, as
   well as company managements, noted that intangible assets are
   an increasingly important economic resource for many entities
   and are an increasing proportion of the assets acquired in many
   transactions. As a result, better information about intangible
   assets was needed. Financial statement users also indicated
   that they did not regard goodwill amortization expense as being
   useful information in analyzing investments.”

   These Standards should shift some of the focus to
   understanding company balance sheets from a market value
   perspective, instead of an historical cost perspective.

 SFAS No. 142 – Goodwill and Other Intangible
   SFAS 142 replaces APB 17 and states that goodwill and
   intangibles with indefinite lives are no longer amortizable.

   Reporting units must be identified and established.

   Impairment testing for goodwill and indefinite-lived intangibles is
   required at least annually based on fair value and consistent
   methodologies.    As such, purchased goodwill and certain
   intangibles are no longer presumed as wasting assets and will
   now remain on the balance sheet and be assumed to have
   indefinite useful lives to be tested at least annually for

   Intangibles with a finite life are amortized over that life (no longer
   a 40 year maximum).


                    Background Summary
   Until implementation of 142, companies could leave overvalued goodwill
   assets on their balance sheets for years, with goodwill being amortized
   for up to 40 years.
   Given the FASB rulings under SFAS 142, this is no longer the case.
   According to SFAS 142, goodwill will have to be written down
   immediately upon being deemed overvalued. Companies may leave
   goodwill on their balance sheet indefinitely only as long as the goodwill
   remains valuable.
   When companies are writing down, they are taking impairment charges
   and are essentially acknowledging that their assets (and thus the
   company itself) will not generate as much cash as previously projected.
   This could impact a management team’s judgment in how much it pays
   for future acquisitions.
   Given the current market and economic environment, many more
   companies are facing impairment now than a couple of years ago.


Introduction – Impairment Testing

  Timing for         How Often?         Relevant FASB
  Ongoing                               Standard
  Intangible assets If indications of   SFAS No. 144
  subject to        impairment
  amortization      (decided by
  Intangible assets mgmt) and on
                    Annually            SFAS No. 142
  with indefinite    indication
  Goodwill           Annually and on    SFAS No. 142


      For Whom Is A 142 Report Prepared?

   Any company (public or private) whose CPAs issue financial
   statements in accordance with GAAP Standards.

   Management of the Company, or its Auditor, may engage an
   appraiser for a valuation in connection with SFAS Nos. 141, 142
   or 144.

   The valuation report should be written to allow the Company and
   its Auditor to evaluate the valuation specialist’s knowledge of the
   business and its underlying intangible assets, whether s/he
   considered all relevant factors, and how the data and
   assumptions were used to determine fair value.


   Fair Value – The amount at which an asset (or liability) could be bought
   (or incurred) or sold (or settled) in a current transaction between willing
   parties, that is, other than in a forced or liquidation sale. Unlike in fair
   market value, fair value for reporting units include synergies (which are
   part of goodwill).
   Goodwill – The excess of the cost of an acquired entity over the net of
   the amounts assigned to assets acquired and liabilities assumed. The
   amount recognized as goodwill includes the acquired assets that do not
   meet the criteria in SFAS 141 for recognition as an asset apart from
   Impairment – The condition of an asset that is carried on the books
   (i.e., carrying amount) at more than their fair value.
   Intangible Assets – Assets (not including financial assets) that lack
   physical substance. (This term is used in the Statements to refer to
   intangible assets other than goodwill.)
   Reporting Unit (“RU”) – The level of reporting at which goodwill is
   tested for impairment. A reporting unit is an operating segment or one
   level below an operating segment.                      
Introduction – Intangible Assets
                    Recognition – SFAS 141
   According to SFAS 141 (¶39), “An intangible asset shall be recognized
   as an asset apart from goodwill if it arises from contractual or other
   legal rights (regardless of whether those rights are transferable or
   separable from the acquired entity or from other rights and
   obligations). If an intangible asset does not arise from contractual or
   other legal rights, it shall be recognized as an asset apart from
   goodwill only if it is separable, that is, it is capable of being separated
   or divided from the acquired entity and sold, transferred, licensed,
   rented, or exchanged (regardless of whether there is an intent to do
   Assembled workforce acquired in a business combination is no longer
   recognized as a separate intangible asset, and should be included in
   The accounting for in-process research and development (IPR&D) is
   not affected by these Standards.
   There are five major categories of intangible assets: marketing-
   related, customer-related, artistic-related, contract-based, technology-
   based.                                                             8

Goodwill - Impairment Testing

   In accordance with SFAS 142, intangible assets with indefinite lives and goodwill
   will be initially tested for impairment at the beginning of the fiscal year (FYE + 1).
   Goodwill must be tested for impairment at least annually. Companies must make a
   one-time selection as to the date that the annual assessments will be performed.
   Interim impairment tests will be required if:
           Events indicate goodwill may be impaired (e.g., adverse changes in business
           climate, personnel, competition, regulations, legal).
           A “more-likely-than-not” expectation exists that a reporting unit (or significant
           portion) will be sold or otherwise disposed of.
           A subsidiary recognizes an impairment loss in its stand-alone GAAP financial
   The impairment test for intangible assets with indefinite lives involves the
   relationship between carrying value and fair value.
   For goodwill, it is a two-part test:
            Step 1: Test the carrying value of the reporting unit(s) vs. fair value.
            Step 2: If carrying value exceeds fair value, then compare the carrying value vs.
           the fair value of goodwill to measure the amount of goodwill impairment loss, if
           any.                                                                  9

Goodwill - Impairment Testing
                       Reporting Unit

Goodwill is not subject to amortization, but is tested for impairment at
the RU level.
This is the same level as, or one level below, a SFAS 131 operating
An operating segment is a component of an enterprise that engages in
business activities from which it may earn revenues and incur
expenses, whose operating results are regularly reviewed by a key
operating decision-maker, and for which discrete financial information
is available.
There is a requirement to drill down one level below the operating
segment (referred to as a component) if certain criteria are met.
SEC continues to scrutinize segment reporting and will likely
scrutinize determination of reporting units.

Goodwill - Impairment Testing
                          Fair Value

   In determining the fair value of a RU, an entity may use:
         Quoted market price of reporting unit’s stock (if publicly traded)
         Prices for similar assets
         Present value techniques (“the best available technique”) such as a
         DCF, where the cash flows are based on the assumptions of
         marketplace participants
         Other valuation techniques (e.g., revenue or earnings multiples).
   Independent appraisals are usually necessary to adequately
   perform Step 2 of the impairment test. Certain entities may have
   expertise in-house to perform Step 1.
   Management’s determination of fair value and any resulting
   impairment charge will be subject to an audit based upon scope,
   materiality, etc.


The SFAS No. 142 Valuation Report
What are the auditors responsible for, and hence, what are
they looking for in a valuation report? They will evaluate the
  The valuation methods used to estimate fair value of the
  acquired assets are appropriate.
  The assumptions underlying the approach(es) used to develop
  the fair value estimates are reasonable in the circumstances
  and reflect market information.
  The valuation method(s) is (are) applied consistently and any
  significant assumptions that reflect management’s intent and
  ability are consistent with management’s plans.
  Management used relevant information that was available at the
  Goodwill is properly valued.
  Any impairment is properly reflected in a RU’s reported
  Note: It is advisable to be familiar with the AICPA’s Fair Value
The SFAS No. 142 Valuation Report
                    Informal Survey
     What do you expect from a valuation specialist?
     What do you expect from the appraiser’s report?
     What are some of the biggest errors you have seen?
     What is your perceived risk in this type of work?
     Is a Step 1 engagement a limited appraisal or an full opinion of
     How should the valuation specialist handle the goodwill
     How should useful lives be determined in a 142 assignment?
     How should the tax amortization benefit be handled?
     Discuss the WACC/rate of return on assets relationship.
     Should a Competency Statement be included in the 142 report?
     Is the volume of this type of work meeting, exceeding, or less
     than your expectations?                             13

The SFAS No. 142 Valuation Report
              Sample Valuation Report
     Valuation Overview
     Identification of Intangible Assets
     Economic, Industry, and Reporting Unit Background
     Valuation Approaches
     Rates of Return
     Valuation of the Reporting Unit (applicable reporting segment)
     Valuation of Identifiable Intangible Assets (e.g., Trademarks,
     Existing Technology, In-Process Research and Development,
     Valuation of the Goodwill (Unidentified Intangible Assets)
     Conclusion of Value
     Terms of Valuation Analysis

The SFAS No. 142 Valuation Report
                      Valuation Overview

 Subject of the Appraisal
 Valuation Date (as of date of the valuation)
 Purpose and Use of the Appraisal
 Results of Analysis
 Summary Description of the Reporting Unit
 Standard of Value (i.e., fair value, not FMV)
 Valuation Considerations
 Background to SFAS 142 and Goodwill Impairment
 Identification of the Reporting Unit
 Goodwill Impairment Testing – Step 1 and Step 2 Procedures


The SFAS No. 142 Valuation Report
         Identification of Intangible Assets

 Intangible Assets Subject to Valuation

 Identification of Goodwill


The SFAS No. 142 Valuation Report
      Economic, Industry, and Reporting Unit

 These sections lay the groundwork for the assumptions to be
 used in the various valuation methodologies.

 Each section must contain significant information that adds
 value to the appropriateness of assumptions used in
 determining the fair value of the reporting unit, its goodwill and
 its separately identifiable intangible assets.

 The report should summarize the relevance of each section and
 state how any external factors (economy and industry) are
 relevant to the subject reporting unit.

 Information on the RU should include a description of its key
 value drivers (e.g., liquidity, access to capital) and historical and
 expected financial performance (e.g., ratio and trend analysis).

The SFAS No. 142 Valuation Report
            Valuation of the Reporting Unit

 The development of a fair value opinion is based on the
 consideration of the three basic approaches to value (income,
 market and asset-based approaches).

 The fair value of the RU’s equity is determined based on a
 reconciliation of the indications of value of the three basic
 approaches, if relevant.

 The definition of “fair value” permits the consideration of
 synergistic effects, applicable to a specific buyer/seller, in the
 assumptions used in the fair value calculation.


The SFAS No. 142 Valuation Report
                       Rates of Return

 A discount rate (WACC) applicable to the RU must first be
 determined before establishing discount rates applicable to
 individual intangible assets.
 The WACC is comprised of the required returns for all of the
 assets employed in the business enterprise. The weighted
 average returns on the allocated assets must relate to the RU’s
 The required rates of return are lowest for working capital
 (representing the least risky assets), incrementally higher for
 other fixed assets including machinery and equipment, and are
 highest for intangible assets.
 Once the rate of return for the intangible assets, in the
 aggregate, is determined (based on the WACC of the RU, less
 the WACC of the company’s tangible assets), then the discount
 rate for each class of respective intangible assets is determined.

The SFAS No. 142 Valuation Report
                 Intangible Asset        Contractual   Separable        Recognize
Trademarks, tradenames                      Yes          Yes                 Yes
Service marks, collective marks             Yes          Yes                 Yes
Trade dress, newspaper mastheads            Yes          Yes                 Yes
Internet domain names                       Yes          Yes                 Yes
Noncompete agreements                       Yes          Yes                 Yes
Assembled workforce                          No           No                  No
Customer lists                               No          Yes                 Yes
Customer base (“walk-ins”)                   No           No                  No
Order or production backlog                 Yes          Yes                 Yes
Noncontractual customer relationships        No          Yes                 Yes
Plays, operas, ballets                      Yes          Yes                 Yes
Books, magazines, other literary works      Yes          Yes                 Yes
Musical works (compositions, lyrics)        Yes          Yes                 Yes


The SFAS No. 142 Valuation Report
             Intangible Asset             Contractual   Separable         Recognize
Pictures, photographs, video                 Yes          Yes                  Yes
Licensing, royalty agreements                Yes          Yes                  Yes
Advertising, management contracts            Yes          Yes                  Yes
Lease agreements                             Yes          Yes                  Yes
Construction permits                         Yes          Yes                  Yes
Franchise agreements                         Yes          Yes                  Yes
Operating, broadcast, use rights             Yes          Yes                  Yes
Service contracts, employment contracts      Yes          Yes                  Yes
Patented technology                          Yes          Yes                  Yes
Computer software                            Yes          Yes                  Yes
Unpatented technology                         No          Yes                  Yes
Databases                                     No          Yes                  Yes
Trade Secrets                                Yes          Yes                  Yes


The SFAS No. 142 Valuation Report
     Valuation Approaches – Intangible Assets
 The income approach is best suited for the appraisal of the following:
 contracts, licenses and royalty agreements, patents, technology,
 trademarks, customer lists and in-process R&D.
 The market approach is often not effective for most intangible assets
 and intellectual property due to lack of adequate market information.
 However, it is first in GAAP’s “hierarchy” in determining fair value.
 The market approach can, however, be utilized in determining
 applicable royalty rates for use in a relief from royalty method.
 The cost approach is based upon the economic principles of
 substitution and price equilibrium, stressing the utility characteristics
 of the asset. Due to its inherent limitations (i.e., in not identifying the
 economic benefits associated with the property), the cost approach is
 best suited for the following types of assets: assembled workforces,
 some customer lists, distribution networks, and corporate practices and


The SFAS No. 142 Valuation Report

                 Example - Trademark

 Characteristic/explanation of trademark.

 Identification of the RU’s trademark and information as to its
 intangible value to the reporting unit.

 Valuation methodology used – Relief From Royalty (RFR)
    Royalty Base
    Royalty Rates
    Net Royalty Savings
    Residual Value Calculation
    Discount Rate Determination
    Tax Amortization Benefit
    Indication of Fair Value


The SFAS No. 142 Valuation Report
                                                        Subject Company, Inc.

                                                  Valuation of the Subject Trademarks
                                                  Relief from Royalty Methodology (1)

                                                                                Forecasted period                                     Residual
                                                2003             2004               2005             2006           2007               Year

Calculation of Royalty Savings:

Revenues                                       $41,044,000     $47,450,000        $54,485,333       $62,658,000    $72,056,667

Royalty Rate                                        2.00%            2.00%              2.00%             2.00%          2.00%
Royalty Savings                                  $820,880         $949,000         $1,089,707        $1,253,160     $1,441,133

Less: Taxes at 40%                               ($328,352)      ($379,600)         ($435,883)        ($501,264)     ($576,453)

Net Royalty Savings                              $492,528         $569,400           $653,824         $751,896       $864,680          $890,620

Capitalized Value for Residual Year (CVRY)                                                                                            $4,947,889

Discount Factor                                     0.9611           0.8397             0.6939           0.5735         0.4740            0.4740

Present Value of Net Royalty Savings             $197,237         $478,125           $453,688         $431,212       $409,858         $2,345,299

Present Value of Net Royalty Savings            $1,970,120
Present Value of CVRY                           $2,345,299

Present Value of Trademark Royalty Flows        $4,315,419

Tax Amortization Benefit                         $654,416

Indicated Fair Value of Trademarks (rounded)    $4,970,000


The SFAS No. 142 Valuation Report

         Example – Employment Agreement

 Characteristics of employment agreements.

 Description of RU’s employment agreements.

 Valuation methodology used – DCF analysis
   Determination of net cash flows with employment agreement in place
   Determination of net cash flows without employment agreement in
   Determination of potential loss of future cash flow due to departure of
   Discount Rate Determination
   Tax Amortization Benefit
   Indication of Fair Value


The SFAS No. 142 Valuation Report
                                           Subject Company, Inc.
                                       Employment Agreement Valuation
                                             Multi-Period Discounted Cash Flow Model

                                                                                         (000's excluded)
                                                                      June 1, 2003 -     October 31, 2003 - October 31, 2004 -
                                                                     October 31, 2003    October 31, 2004 October 31, 2005

 Debt-Free Net Cash Flow - With Agreement in Place                              $4,110              $4,433             $6,140

 Debt-Free Net Cash Flow - Without Agreement in Place                           $2,790              $2,473             $4,594

 Potential Loss of Net Cash Flow                                                $1,320              $1,960             $1,546

 Discount Factor                                                                0.9611              0.8397             0.6939

 Present Value of Potential Lost Net Cash Flow                                    $529              $1,646             $1,073

 Indicated Value of Employment Agreement before Tax Benefit                     $3,248

 Tax Amortization Benefit                                                         $492

 Fair Value of Employment Agreement                                             $3,742


The SFAS No. 142 Valuation Report
 Valuation of the Goodwill (Unidentified Intangible

 Goodwill is defined in the International BV Glossary as “that
 intangible asset arising as a result of name, reputation,
 customer loyalty, location, products, and similar factors not
 separately identified.”
 Although conditions or influences that may exist which indicate
 the existence of, and greatly contribute to the value of goodwill,
 these components have not been separately identified and
 evaluated as they lack one or more of the requisite attributes to
 be identified as a distinct intangible asset (unidentified intangible
 The value of goodwill is determined using a residual method
 based on the enterprise market value (i.e., the fair value of the
 RU less all other identified assets).


The SFAS No. 142 Valuation Report
     Simple Example of a Goodwill Impairment Calculation:

                                                                 A             B
     Step 1:
          FV of Reporting Unit                                    $1,000          $500
          BV of Reporting Unit                                     (600)         (600)
                                                                    $400        ($100)
                                                                  PASS          FAIL
     Step 2:
          FV of Reporting Unit                                    Step 2          $500
          FV of Reporting Unit's tangible net assets                 n/a         (225)
          FV of Reporting Unit's intangible assets                               (200)
            Implied FV of Goodwill                                                 $75
            BV of Reporting Unit's Goodwill                                      (200)
            Goodwill Impairment Loss                                            ($125)

   Source: Presentation by Geoffrey P. Melrose and Richard Whalen of Duff & Phelps, “Valuation
   for Financial Reporting Purposes” at the ASA Advanced BV Conference in Seattle, 2001.


The SFAS No. 142 Valuation Report
                      Conclusion of Value

 Conclusion should state the opinion of fair value of the RU, less
 the fair value of the identified intangibles and less the fair value
 of tangible assets.
 The residual value (the fair value of the reporting unit less the
 fair value of the identified intangible and tangible assets), is the
 goodwill of the RU.
 The appraiser need not opine as to the calculated impairment
 amount. The impairment is a calculated amount, based on the
 level of goodwill, according to fair value of the entity’s equity (as
 compared to an adjusted net asset value, as determined by a
 third party) and the level of goodwill, as recorded on the entity’s
 financial statements.
 Goodwill and intangibles only get marked down, they never get
 marked up. While negative goodwill can exist in an acquisition,
 it does not in this process (i.e., it only can go down to zero).

The SFAS No. 142 Valuation Report
                       Conclusion of Value
Fair Value of Reporting Unit                           $10,000,000
Fair Value of Intangibles:
Customer List                                          $1,000,000
Existing Technology                                    $2,000,000
In-Process Research and Development                    $3,000,000
Total Fair Value of Intangibles                        $6,000,000

The residual amount of goodwill has been separately calculated at
approximately $2,000,000 (Section ___). This is based on the fair value of
the Reporting Unit and its Intangibles that have been determined by
VALFIRM, and the value of the fixed assets and working capital that have
been determined by parties not affiliated with VALFIRM. VALFIRM is not
qualified to render opinions pertaining to the value of real estate or
machinery and equipment, and therefore expresses no opinion or any
other form of assurance on the their values stated herein. Any changes to
these outside opinions of value will impact the calculated value of goodwill.


The SFAS No. 142 Valuation Report

 Listing of relevant assumptions and limiting
 Sources of information relied upon.
 The fair value measurement (“FVM”) specialist’s
 professional qualifications and competency


Delphi Valuation Advisors, Inc. Contact

            Chris M. Mellen, ASA, MCBA, MBA
             Delphi Valuation Advisors, Inc.
                    171 Edgehill Road
                 Sharon, MA 02067-1058
                  Phone: (781) 793-5610
                   Fax: (781) 793-5612



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