Valuations for Financial Reporting (ASC 805, ASC 718)

Determining the fair market value of an enterprise requires the consideration of a number of factors, including the historical financial performance of the company, as well as reasonable expectations about its future economic prospects. Market data pertaining to the company’s specific industry and their specialization within that industry is also reflected in the valuation.

The valuation analysis will contain several different valuation methods in order to narrow the reasonable range of equity values and draw a conclusion regarding the value. In each of the valuation approaches utilized in our analysis, we estimate the whole equity value by dividing it into the components of return and risk. These components each have sub-components of their own. 

Returns are expressed in cash values such as revenues, earnings, cash flows and other benefit streams. Risks are expressed as discount rates or in adjustments to valuation multiples. Many of the parts are interrelated. For example, a relatively high growth rate assumption for comparable publicly traded companies as a group is accompanied by higher risk that the company will not be able to achieve a growth rate equivalent to those projected for the public companies in the future. Future growth is a part of the overall return; risk and return are related.

Professional judgment is also applied in the valuation process, especially when applying the market data to the unique circumstances of the company being valued. Judgment is required because financial models alone cannot accurately describe the economic reality of the company.

There is no such thing as a reliable “valuation formula” for appraising the equity of a company because the future will not necessarily resemble the past, past data is limited, and formulas, financial models and mathematical models cannot entirely capture all of the relevant factors that must be considered in a valuation of a company.

We select the fair market value from a range of values indicated by the Discounted Cash Flow Method, the Public Guideline Company Method and the Private Transactions Method. When appropriate, other valuation methods, such as the Capitalized Earnings Method or the Net Asset Value Method are considered.  

Frequently, clients will enter into Management Services Agreements (“Agreement”) in which a separate entity will provide management services to a physician or physician practice for a predetermined fee. When there is common ownership between the management company and physician or physician practice, a commercially reasonableness and fair market value (“CR FMV”) analysis maybe required. 

The Centers for Medicare & Medicaid Services (“CMS”), then known as HCFA, in the 1998 Stark proposed rule, interpreted “commercially reasonable” to mean that an arrangement appears to be a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.” Later, in the preamble to the Stark interim final rule, Phase II, CMS noted that an arrangement “will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice of similar scope and specialty), even if there were no potential DHS referrals.” 69 Fed. Reg. (Mar. 26, 2004), p. 16093.

Valuations for Financial Reporting Purposes (Purchase Price Allocations, Intangible Asset Valuations, Goodwill Impairment Testing)

BTV performs valuations to assist management for financial reporting purposes in accordance with Generally Accepted Accounting Principles (“GAAP”) and to support the audit of the company’s financial statements. These types of valuations are performed based on the Fair Value standard.

Definition of Fair Value

This fair value measurement was provided in accordance with Financial Accounting Standards Board Accounting Standard Codification 805 and 820 (“ASC 805” and “ASC 820”), (formerly Statement of Financial Accounting Standards No. 157, Fair Value Measurements), which defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date” (“Fair Value”). 

ASC §820 states that a fair value measurement assumes the highest and best use of the asset by market participants, considering the use of the asset that is physically possible, legally permissible and financially feasible at the measurement date. In broad terms, highest and best use refers to the use of an asset by market participants that would maximize the value of the asset or the group of assets within which the asset would be used. Moreover, the highest and best use is based on the use of the asset by market participants, even if the intended use of the asset by the reporting entity is different.

The highest and best use of the asset by market participants establishes the valuation premise used to measure the fair value of the asset: (1) in-use, if the asset would provide maximum value to market participants principally through its use in combination with other assets as a group, installed or otherwise configured for use; or, (2) in-exchange, if the asset would provide maximum value to market participants principally on a standalone basis.

Purchase Price Allocations

According to ASC 805, all business combinations are to be accounted for exclusively by the Acquisition Method. Under this method, all identifiable assets acquired, liabilities assumed, and any non-controlling interest should be stated on the financial statements at fair value, as previously defined. According to ASC 805, an intangible asset is considered identifiable in a business combination if it meets either the separability criterion or the contractual-legal criterion. An intangible that is separable is capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so. ASC 805 also requires disclosure of the primary reasons for a business combination and the allocation of the purchase price paid to the assets acquired and the liabilities assumed.

Goodwill reflects 1) the excess of the reorganization value of the successor over the fair value of tangible and identifiable intangible assets, net of liabilities, from the adoption of fresh start reporting, adjusted for impairment, and 2) the excess of purchase price over the fair values of the tangible and identifiable assets acquired and liabilities assumed.

To determine the specific valuation methods to be utilized in determining the value, we will perform different investigative procedures including interviews with management regarding the history of the business, as well as detailed discussion of the company’s recent financial performance and operations of the company, its expected future performance, and other factors we considered relevant. We will review, analyze and interpret both internal and external factors influencing the value of the company. 

Valuation of Intangible Assets

The intangible asset valuation is an estimate of the fair value within the meaning of the defined Standard of Value. In accordance with ASC 805, Business Combinations, and based on discussions with management, BTV will identify separable intangible assets as of the valuation date. We frequently perform valuations of the following intangible assets:

• Marketing-related Intangible Assets - Trademarks, trade names, service marks, internet domain names, and non-compete agreements.
• Customer-related Intangible Assets - Customer lists, backlog, customer contracts, and customer relationships. 
• Artistic-related Intangible Assets  - Books, magazines, motion pictures, musical compositions, photographs, and plays. 
• Contract-related Intangible Assets - Advertising contracts, broadcasting rights, franchise agreements, licensing agreements, and mineral rights.
• Technology - related Intangible Assets - Computer software, databases, patented technology, trade secrets, and unpatented  technology. 

We will utilize specific valuations methods, when appropriate, to value intangible assets. In the valuation of intangible assets, elements of the income approach and the market approach may be used simultaneously. For example, in the valuation of a trademark, a market investigation establishes a current fair royalty, which is used as the basis for a projection of royalty savings to be discounted to present value. 

Relief from Royalty Method

A common method to value intangible assets under the income approach is the Relief from Royalty Method. Valuation using the relief from royalty method is based on the concept that if a company owns intellectual property, it does not have to “rent” the asset and therefore is “relieved” from paying a royalty. The amount of such a phantom payment is used as a surrogate for income attributable to the intellectual property, and the pre-tax income attributable to the intellectual property can be calculated. The income derived from the intellectual property can be capitalized into perpetuity or discounted using a discounted cash flow analysis, depending on the anticipated life of the intellectual property. 

Multi-period Excess Earnings Method

Another indication of value derived under the income approach is determined by the Multi-period Excess Earnings Method. Excess earnings are defined as the residual of cash flow generated by the revenue related to the intangible asset after providing for appropriate returns on supporting assets of the business. This methodology utilizes the cash flow generated by the revenue relating to the intangible asset less an economic charge for the supporting assets to derive the cash flow generated by the intangible asset. Such cash flow is then discounted at a rate of return commensurate with the risk of generating the cash flows. By including returns on supporting assets in the valuation model, an allowance is made for fair returns on assets that are required to realize the related cash flows. These other supporting assets comprise any tangible or intangible assets that are required to generate the projected revenue. For any instance where multiple assets contribute to the generation of cash flow, supporting asset charges can be used to derive the cash flow attributable to each individual asset. Generally, assets have two types of required returns, return on the asset and a return of the asset. The return on the asset reflects a fair return for the use of the asset. The return of the asset reflects a repayment for the deterioration of the asset. Returns of an asset are reflected in depreciation and amortization expenses and similar expenses in the forecast.

Tax Amortization Benefit

According to IRC § 197, all eligible intangible assets are amortized over a specific number of years (currently 15) regardless of their expected life. The amortization of acquired intangible assets reduces taxable income, thus creating an amortization tax benefit. Consequently, the present value of the intangible assets’ projected cash flows should reflect the tax benefit that may result from amortizing the new tax basis in the intangible asset.