BVA July 2009

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Impairment testing of goodwill and long lived assets in the current environment

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BVA July 2009

  1. 1. CONTENTS Impairment Testing of Goodwill, 1 Indefinite and Long-lived Assets In Impairment Testing of Goodwill, Indefinite and the Current Environment Long-lived Assets in the Current Environment 2 by PJ Patel, CFA, ASA ment amounts are allocated to identifiable Editors’ Column impaired assets before finally determining The current financial and economic envi- goodwill impairment. No asset is impaired 3 ronment has had a significant impact on to a value that is less than its fair value. Social Media: What Is It and financial statements. As companies test Should You Care? their assets for impairment, many have Order of Operations taken significant non-cash impairments The testing methodology requires in- 6 Social Media Is Here To Stay of goodwill, intangible assets, and even definite-lived assets to be tested first, PP&E, causing their balance sheets to followed by long-lived assets, and finally 7 shrink. As the economic turmoil persists, goodwill. In each step, the carrying value A Tale of Two FLP Estate Tax companies will continue to recognize im- of assets is adjusted before subsequent Cases: Facts and Judges pairments on a variety of assets. impairment tests. Differ Under US GAAP, impairment testing is For instance, the order of operations for 9 ASB Adopts New Disclosure covered by SFAS Nos. 142 and 144. SFAS impairment testing of a company with a Requirements for 2010-2011 No. 142 provides guidance on the testing single reporting unit which consists of a Edition of USPAP and impairment of goodwill and indefinite- single asset group and a single indefinite- lived intangibles; SFAS No. 144 provides lived trademark would be as follows. 15 guidance on the testing and impairment Calendar of long-lived assets. These documents are 1. Trademark would be tested for impair- supplemented by other FASB literature ment. If impaired, the carrying value of such as SFAS No. 157, EITF 02-7, EITF the trademark would be adjusted for the 02-13 and various SEC speeches and audi- calculated amount of the impairment. tor interpretations. 2. The asset group would be tested for impairment by comparing undiscounted cash flows with the fair value of the as- Background: set group including the trademark at its The Structure of adjusted fair value. Impairment Testing a. If the asset group was determined to be impaired, the carrying value of SFAS Nos. 142 and 144 collectively long lived assets would be adjusted provide guidance for testing goodwill, for impairment. VOL. 10, ISSUE NO. 3 indefinite-lived and long lived assets for 3. Goodwill impairment is tested by com- impairment. While each asset category has a unique testing methodology, together a paring the fair value of the reporting unit to the carrying value based on prior JULY systematic approach (and closed model) adjustment/impairments. The fair value for impairment testing is evident. Impair- CONTINUED ON PAGE 10 2009
  2. 2. JULY 2009 George B. Hawkins is president of Banis- ter Financial, Inc., a firm in Charlotte, North EDITORS’ COLUMN Carolina, specializing in business valuations. He is certified as an The turmoil in the stock market has led to a dramatic increase in goodwill Accredited Senior Ap- impairments. According to a recent study released by PricewaterhouseCoopers, praiser (ASA) in busi- Fortune 500 companies announced $230 billion of impairments from third ness valuation and a quarter 2008 through March 20, 2009. That amount is more than double the Chartered Financial amount on record for Fortune 500 companies for the prior three years! Analyst (CFA). He also has an M.B.A. from Wake Forest University and is the current Vice Chair of the Interna- To provide some insights into this timely topic, we have an article by PJ tional Board of Examiners of the American Patel, CFA, ASA, of Valuation Research Corporation, “Impairment Testing Society of Appraisers’ business valuation of Goodwill, Indefinite and Long-lived Assets in the Current Environment.” section. Hawkins serves as an elected member The article discusses SFAS Nos. 144 and 142, which “together provide a of the Business Valuation Committee of the American Society of Appraisers. comprehensive framework for testing the various long-lived and indefinite lived assets for impairment.” Michael A. Paschall is executive vice presi- Continuing our discussion of FLPs from our last issue, we have another article dent and a director of by Owen G. Fiore, JD, of Fiore Wealth Planning Consulting. “Tale of Two FLP Banister Financial, Estate Tax Cases: Facts and Judges Differ” reviews two recent FLP estate tax Inc., a firm in Char- lotte, North Carolina, cases: Estate of Erma V. Jorgensen v. Commissioner et al., TC Memo 2009-66, specializing in busi- and Estate of Valeria Miller v. Commissioner, TC 2008-128. ness valuations. He is certified as an Accred- “Perhaps the primary lesson to be learned in analyzing these new cases is that ited Senior Appraiser each FLP/FLLC case is unique,” writes Fiore, “not only by reason of varying (ASA) in business valu- ation and a Chartered facts but also due to the individual Tax Court judge’s evaluation of case specif- Financial Analyst (CFA). He also has a J.D. ics and developed views on estate tax issues involved.” from Wake Forest University and is an Advi- sor of the International Board of Examiners of Fiore notes that “business valuation appraisers can learn from these cases about the American Society of Appraisers’ business the key factors considered important in determining whether the pass-through valuation section. entity, whether an FLP, FLLC, or even an S corporation, will be respected for estate tax purposes.” Rounding out our issue is an article by Barbara Walters Price, Senior Vice President of Marketing for Mercer Capital Management, on using CONTRIBUTING EDITORS social media to market your business valuation practice. “If the idea of George B. Hawkins, ASA, CFA Michael A. Paschall, ASA, CFA, JD social media intrigues you and you can see benefit to you and your firm, MANAGING EDITOR begin to participate,” advises Price. Kurt Diefenbach EDITOR “Social Media: What is It and Should You Care?” discusses how busi- Lou Dagostino Elaine Stattler ness valuation professionals can best utilize social media tools such as Laura Naus Holland LinkedIn, Google Profile, Twitter, and blogs. Price warns, though, that PUBLICATION DESIGN “social media can distract you from the importance of other marketing Don Torres tools.” “Don’t neglect e-mail newsletters, direct mail, and other targeted CCH BUSINESS VALUATION ALERT (ISSN marketing tactics,” Price advises. “While social media extends your reach, 1520-3158), published quarterly by CCH, a Wolters Kluwer business, 4025 W. Peterson, Ave., it is a tool in your toolbox. It is not the toolbox.” Chicago, Illinois 60646-6085. POSTMASTER: SEND ADDRESS CHANGES TO CCH BUSINESS — George B. Hawkins VALUATION ALERT, 4025 W. Peterson Ave., Chi- cago, IL 60646. Printed in U.S.A. ©2009 CCH. All Rights Reserved. — Michael A. Paschall This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, ac- counting or other professional service, and that the au- thors are not offering such advice in this publication. If legal advice or other expert assistance is required, the services of a competent professional should be sought. All views expressed in the articles and columns are those of the author and not necessarily those of CCH or any other person. 2
  3. 3. JULY 2009 Social Media: What Is It and Should You Care? by Barbara Walters Price ■ “Attorney Thomas N. Shorter … a shareholder in the Madi- son office of Godfrey & Kahn, S.C., says he has LinkedIn Overview set as his homepage. Every time one of his 200 or so con- Social media tools have transformed the Web from a one- nections adds a connection, he is notified of that. If the new way communication vehicle to a real-time and interactive connection is someone that Shorter would like to know medium. professionally, he telephones his connection and asks him or her to make an introduction. This has happened a number This article is addressed to business valuation professionals. Its of times since joining LinkedIn … and he has garnered a purpose is to help you make sense of social media and decide number of new cases and clients via this method.” if it is right for you and your practice. ■ “Among the Davis & Kuelthau s.c. lawyers … was a partner who was skeptical [of social media] at first. But … in response We will introduce a few tools that might be useful, talk about to two of his e-mails asking clients to connect, not only did the potential benefits and shortcomings of your participation, they accept his invitation, but also, they contacted him, saying and suggest a strategy to help get started, should you decide “I’ve been meaning to get in touch with you about …. Two new to test the waters. matters landed on his plate, with very little effort on his part.” ■ Rick Telberg, president and CEO of Bay Street Group LLC Social Media Can Help You and Your Firm and well-known author of CPA Trendlines, retells the Twitter The greatest potential benefit of social media is its ability to success story of Andrew Rose, director of marketing and generate broader exposure for you and your firm. This expo- business development of Naden/Lean CPAs of Timonium, sure will result in: Maryland. Twitter helped Naden/Lean improve their search engine ranking. Per Andrew: 2 ■ Networking opportunities with current clients, as well as people you would not otherwise have knowledge of or access to; … I started Twitter searching to see what people were ■ Increased traffic to your Web site; saying, er, tweeting, about us. You can imagine my sur- ■ A rise in the search rankings for you and/or your firm; prise when I found a post related to an industry niche ■ Strengthening of your personal and professional brand; and blog we run describing how valuable our advice was. It ■ A powerful recruitment and retention tool for the millennial was from someone I didn’t know. So I began following generation. him and thanked him for recognizing us in this public fashion, unsolicited. FIGURE 1 And, the kicker? His tweet, reposting a link to our in- dustry blog now ranks in the top 20 for a keyword in an organic Google search.” Focus on Giving, Not Getting To be effective in social media, you need to approach it with the right attitude. Focus on giving—providing information and resources. From there, you will see the most benefit. Says Debra Helwig, marketing communications manager of IGAF Worldwide and author of the blog Service Minded (www. debrahelwig.wordpress.com) “All of it [social media] is putting bread on the water. You have to focus on giving, not getting. You must first be ready to learn and absorb and give back.” Select the Right Tools Many successful business appraisers get their best work by It has been said that 80 percent of the fuel on the space shuttle word-of-mouth marketing (referrals). Increasingly, social is used to get the shuttle into orbit, and rest of the mission relies media is moving word-of-mouth marketing online. Here are upon the remaining 20 percent. So it is with social media. 80 some examples of this phenomenon from law firms using percent of your efforts will be dedicated to just getting off the LinkedIn1 and Twitter: ground, so choosing the right tool is important. CONTINUED ON PAGE 4 3
  4. 4. JULY 2009 Social Media over search results, Google has provided Google Profile, which allows users to create a one-page bio. Users can add CONTINUED FROM PAGE 3 links to Web sites, blogs, on-line photos, and other social networking profiles such as LinkedIn and Facebook. People If you are ready to jump into social media, let me offer the will see it on their results page when they do a Web search following advice to business valuation professionals based for the user’s name. upon my experience as the marketing director in a business valuation firm. The tools recommended below are listed in To create a profile of your own, create an account with order of importance given the limited time resources every Google. Then visit www.google.com/profiles/me and follow business appraiser has. the directions. A profile can be completed in less than an hour. Remember to set up a profile page for your firm as well. (For LinkedIn. LinkedIn is a business-oriented social networking an example of a Google Profile, visit mine at www.google. site designed for professional networking. This fact sets it com/profiles/barbarawaltersprice.) apart from other popular social networking sites. LinkedIn is a powerful networking tool if used correctly. Twitter. Twitter is a free micro-blogging site. Entries, known as tweets, are limited to 140 characters. Twitter seems to be If you only have time to commit to one social media tool, more of a one-way, one-to-many communications tool rather make it LinkedIn. Join LinkedIn, complete your profile, join than a two-way, peer-to-peer communications network, yet it several LinkedIn groups, and begin to build your network of is worth considering. “connections,” as LinkedIn calls your contacts. My advice is to begin to find people to follow (via Twitter Leverage the tool by updating your status at least weekly. Reach search, Twibes, or FollowMe), then lurk for a while to see out to contacts for their input on article ideas or speeches, upload what others are saying about you, your firm, or a practice recent presentations, let your connections know when you will niche. Then decide if you have the time to contribute content be in town, and join in the discussions in groups to which you or can offer content that others might find useful. Focus the belong. Once your profile is complete, spend at least an hour content on the professional, not the personal. a week on LinkedIn, building your contact base. A tutorial on LinkedIn is beyond the scope of this article, but begin with the Twitter is a useful tool to point followers back to your Web Help section of the service itself. In addition, there are several site or blog. If you have 15 to 30 minutes a day to devote, and other Web sites that offer useful information.3 you have worthwhile content, give it a try.7 Chris Mercer, CEO of Mercer Capital, recently sent an e-mail You can also use Twitter to help obtain press coverage. There are to his LinkedIn connections to solicit advice on an upcoming thousands of reporters on Twitter. Find those who write about speech. “I received three responses on areas that I had not subject matter you can comment on, and follow them. You might thought to touch on but they ultimately enhanced the speech. learn of a story they are writing to which you can contribute. I saw two other benefits from this use of LinkedIn. I commu- nicated to my network that I was speaking on this topic and According to Compete.com, as of February 2009, Twitter was then I sent a copy of the PowerPoint slides after the speech as ranked as the third most used social networking site8 although yet another touch. Without the functionality of this tool, this as of May 2009, its growth appears to have slowed.9 would have been too difficult to even attempt.” Blog. The term “Blog” is an acronym for “Web log” and is a type Why is LinkedIn my first recommendation? As of May, 2009 of Web site designed for journal-type entries. Each entry, or post, LinkedIn had more than 40 million registered users spanning is presented in chronological order with the most recent post top- 170 industries.4 LinkedIn is free to use, although there are paid ping the list. Most blogs are textual, yet some are video-oriented options that allow greater flexibility in contacting others. (vlogs), audio-oriented (podcasts), or photo-oriented (photob- logs). Micro-blogging has also become popular via Twitter. Remember that we have to know our target market(s). Attorneys are still a valued referral source category for many business ap- As of December 2007, Technorati.com was tracking 112 praisers, and attorneys have embraced LinkedIn. As of June 2009, million blogs.10 A little over half of all blogs tracked in 2008 LinkedIn shows 840,000 people within the law practice industry concentrate on personal or lifestyle topics and over a quarter and, of those 840,000, a high percentage are lawyers.5 That is a focus on business topics.11 106 percent increase from December, 2008.6 So you’ll want to spend time where many in your target market spend time. A blog, done well, can be an extremely effective marketing tool. A blog can showcase particular expertise and experience. It can Google Profile. Google handles millions of vanity searches create a conversation with readers via the comment function. It can every day (“googling yourself”). To provide more control also improve search rankings and drive traffic to your Web site. 4 © 2009 CCH. All Rights Reserved
  5. 5. JULY 2009 While it is easy to set up a blog, it is difficult to maintain one. YouTube. YouTube allows users to upload and share video clips. This is the reason it is listed fourth in order of importance You can also paste videos from YouTube to blogs, Web sites, and on my list. A blog needs to have a sharp content focus and other social networking sites. Videos appear in Google search results be constantly fed. Authors should post at least twice a week, and video. If thoughtfully done,YouTube can be an effective way to preferably three times a week. This requires a large commit- present yourself, your firm, or a particular topic of interest. ment of time and resources. These are some of the most popular social media tools and There is currently a void in the business valuation space for a well- those I believe might be most beneficial to readers. This list is written blog. Only a few business valuation-themed blogs could not all-inclusive. A more comprehensive list of social media be identified for this article and they are not often updated. marketing tools can be found at the blog Junta42blog.15 Before you begin to blog, know what your blog will be about, Be Aware of the Possible Shortcomings identify the author(s), draft several posts for future publication, Social media is not a panacea and it is not for everyone. Al- and commit to it for at least a year. Then decide upon the ap- ways keep in mind that there are opportunity costs attached propriate blogging platform for your needs, design, and launch. to everything we do. Consider the following: Promote your blog in all your other marketing channels, link to other blogs, and leave comments on other blogs. 1. Time. One of the biggest opportunity costs is time. Social media participation can be time intensive. Many marketing experts Jerry Work, president of Work Media Internet Marketing, says advise posting to a blog at least three times a week, tweeting at “Really, you just have to remember that you’re not blogging least three to five times a day, updating your status on LinkedIn just to sell stuff—you are trying to build a community of several times a week, participating in pertinent group discus- people who are interested in what you have to say, and you sions, and updating your Facebook status several times a week. are participating in a larger community-wide discussion that Social media can easily consume half an eight-hour workday involves your blogs, as well as the blogs of others.”12 or more if you don’t have concrete goals and parameters. 2. Loose Cannons. Understand that you cannot always control the Facebook. Lastly, consider joining Facebook. It is the most popu- message. If your employees are engaged in social media, there lar free-access social networking site with more than 200 million is always the possibility that they may post something unflatter- users worldwide and over 60 million in the United States.13 ing. For example, this year, an ad agency executive representing Ketchum was in town to make a digital media presentation to According to the istrategylabs.com 2009 Facebook Demo- his client, FedEx, headquartered in Memphis, Tennessee. graphics and Statistics report, the 35-54 year old demographic The ad agency executive got into trouble when he tweeted is growing fastest, followed by the 55-or-older group. The unflattering remarks about the city of Memphis. It turns out 25-34 year population is doubling every six months.14 that FedEx workers were among his Twitter followers and they did not react well to a vendor insulting their city. It Facebook is primarily used for personal social networking (cur- caused embarrassment on many levels. rent friends, old friends from high school and college, family, Here’s the takeaway: If you, as an individual, believe in the etc.). Contacts are called “friends.” But many users also incor- virtues of being blunt, stay away from social media. People porate professional applications. People use the status updates forget the massive reach of social media. Also, be aware that feature on Facebook to inform their network about blog posts, many, if not most, of your employees or colleagues are already videos, or other items of broader professional interest. engaged in social media in some form. A prudent course of action is to instate a social media policy at your firm.16 Consider These As Well In another example, two employees at Domino’s Pizza posted HARO. Subscribe to HARO, or Help a Reporter Out. Philip a supposedly humorous video on YouTube in which they were Shankman, a self-described CEO, entrepreneur, and adven- doing some disgusting things while making sandwiches. That turer, began this project. Over 100,000 people subscribe to this video “went viral.” While these were isolated acts by employees free service. They receive at least three e-mails a day filled who claimed they didn’t serve the contaminated food, they were with queries from reporters about stories they are working on. subsequently arrested for food tampering and Domino’s had a The queries range from lifestyle to technology to business. If huge PR catastrophe to deal with. you see a query you can answer, contact the reporter directly. 3. Distraction. Don’t ignore your other marketing tools. Social To subscribe, visit http://www.helpareporter.com. media can distract you from the importance of maintaining your other marketing strategies. Before spending a great deal Ning. Ning allows you to create your own social network of time on social media, make sure your Web site is up-to- around a subject of interest with your own visual design, choice date and full of useful content. Your Web site is still your of features and member data. Customization is an important premier marketing tool and each social media tool should feature, as users automatically have a customizable profile drive traffic to it. Don’t neglect e-mail newsletters, direct page. Ning offers both free and paid options. CONTINUED ON PAGE 6 5
  6. 6. JULY 2009 Social Media Barbara Walters Price is the Senior Vice President of Market- ing for Mercer Capital Management, Inc., a business valu- CONTINUED FROM PAGE 5 ation and investment banking firm. E-mail her at priceb@ mercercapital.com, visit her blog, BW Price’s Marketing U, at mail and other targeted marketing tactics. Finally, and most www.bwprice.com, or link to her on LinkedIn at http://www. important, social media does not take the place of in-person linkedin.com/pub/6/960/164. ◆ meetings. While social media extends your reach, it is a tool in your toolbox. It is not the toolbox. End Notes 1 Pribek, Jane, Wisconsin Law Journal, (September 22, 2008), “Attorneys Before you begin any marketing strategy, much less a social are Getting LinkedIn to Clients Online,” http://www.wislawjournal.com/ media marketing strategy, identify your target market(s), article.cfm?recID71415 (Access June 15, 2009). 2 develop clear objectives, and devise a strategy. Then review Telberg, Rick, CPA Trendlines (March 24, 2009), “How Twitter a variety of social media tools and choose those that have the Launched a CPA Firm into the Top Google Rankings,” http://cpatrend- greatest chance to accomplish your goals. lines.com/2009/03/24/how-twitter-launched-a-cpa-firm-into-the-top- google-rankings (Accessed June 15, 2009). Conclusion 3 Mashable, Wallace, Brian (November 2, 2008), “How to Get the Most If the idea of social media intrigues you and you can see benefit Out of LinkedIn,” http://mashable.com/2008/11/02/reexamining-linke- to you and your firm, begin to participate. As Kelly Hutson of din/ (Accessed June 16, 2009). Techlifeweb.com, “Become a LinkedIn ProCommunicator (www.procommunicator.com) wisely ad- Power User,” http://www.techlifeweb.com/2008/10/29/become-a-linked- vises, “I’d caution you not to jump into the deep end of the social in-power-user/ (Accessed June 16, 2009). LinkedIn Questions.wordpress. media tool pool and start posting all your photos and commenting com: “LinkedIn Expert Advice & Insight Through Your Questions—A on the state of the Union. [M]ake a decision early on what each LinkedIn Blog That Goes Beyond the “Official” Explanations,” http:// of these tools is meant to accomplish for you. Is it for personal linkedinquestions.wordpress.com/ (Accessed June 16, 2009). 4 relationships? Business contacts? Purely professional?” Wikipedia, http://en.wikipedia.org/wiki/Linkedin (Accessed June 14, 2009). 5 Stem: Law Firm Web Strategy Blog, http://www.stemlegal.com/ I have found participation in social media to be both profes- strategyblog/2009/linkedin-lawers-hit-840k (Accessed June 12, 2009). 6 sionally and personally rewarding. I have received invitations Ibid. 7 to speak and opportunities to publish articles directly as a result Mashable, Philip, Bruce, (June 12, 2009), “5 Habits of Successful Execu- of my blog. In addition, search results for my firm improve tives on Twitter,” http://mashable.com/2009/06/12/twitter-executives/ when I post about the firm’s activities. Through my network (Accessed June 15, 2009). 8 on LinkedIn, I have met other professionals who I never would Compete.com. Kazeniac, Andy (2009-02-09). “Social Networks: Fa- have otherwise known, and I have received invaluable help with cebook Takes Over Top Spot, Twitter Climbs,” http://blog.compete. publishing projects as well as marketing advice for my firm. com/2009/02/09/facebook-myspace-twitter-social-network/. 9 Harvard Business Blog, Heil, Bill and Piskorski, Mikolaj (June 1, 2009), To quote a commenter to a recent blog post on social media, “At “New Twitter Research: Men Follow Men and Nobody Tweets,” http:// the end of the day it is about human interaction. It’s nothing com- blogs.harvardbusiness.org/cs/2009/06/new_twitter_research_men_follo. plicated—technology simply empowers these processes.”17 html (Accessed June 15, 2009). 10 Wikipedia, http://en.wikipedia.org/wiki/Blog. (Accessed June 14, 2009). 11 Good luck in your journey. Technorati, “State of Blogosphere 2008.” http://technorati.com/blogging/ SOCIAL MEDIA IS HERE TO STAY Social media advocates proclaim that there is a sea change underway in the manner in which we communicate and dis- seminate information. What are some examples? ■ When a bystander snapped a picture on an iPhone of U.S. Airways Flight 1549 floating in the Hudson River and sent it via Twitter to friends, who sent it to friends, who sent it to friends, and it appeared on local and national news—all in real time—that is social media in action. ■ When a 47 year old Scottish woman, Susan Boyle, wows Britain and the world via a YouTube video, that is social media in action. ■ When people create “groups” on Facebook around causes about which they are passionate and find like-minded people to join who, in turn, find like-minded people to join, that, too, is social media in action. It is what Seth Godin, marketing expert, calls creating “Tribes.” One point should be acknowledged—social media is already a fact of life! 6 © 2009 CCH. All Rights Reserved
  7. 7. JULY 2009 15 state-of-the-blogosphere/the-what-and-why-of-blogging/. 54% of blogs Junta42blog, http://blog.junta42.com/content_marketing_ tracked focused on personal/lifestyle subjects. 27% of blogs tracked fo- blog/2009/06/42-online-content-sharing-and-productivity-tools.html. 16 cused on business topics. For a good example of a social media policy template, see Law. 12 Quoted from the soon-to-be-released, yet-to-be-titled social networking com Legal Technology, Wong, James (June 15, 2009), “Draft- book written by Jerry Work of Work Media Internet Marketing. Jerry gra- ing Trouble-Free Social Media Policies,” http://www.law.com/jsp/ ciously allowed me to review a draft copy. It is packed with useful infor- legaltechnology/pubArticleLT.jsp?id=1202431410095&src=EMC- mation and it is not written in techo-speak. Any professional can pick it up Email&et=editorial&bu=LTN&pt=Law%20Technology%20News&cn=l and glean helpful information immediately to allow them to get started in tnda_20090615&kw=Drafting%20Trouble-Free%20Social%20Media%2- social media. Visit http://.workmedia.net to inquire about the book. 0Policies (Accessed June 17, 2009). 13 17 Wikipedia, http://en.wikipedia.org/wiki/Facebook. (Accessed June 14, 2009). Comment from Adrian Eden (June 10, 2009) to the post “5 Biggest Les- 14 Istrategylabs, http://www.istrategylabs.com/2009-facebook-demograph- sons I’ve Learned About Using Social Media” by Kelly Hutson (Pro- ics-and-statistics-report-276-growth-in-35-54-year-old-users/ (Accessed Communicator.com). http://www.procommunicator.com/social-media/ June 14, 2009). the-5-biggest-things-ive-learned-about-using-social-media. A Tale of Two FLP Estate Tax Cases: Facts and Judges Differ by Owen G. Fiore, JD then concluded the second round of contributed assets were essentially testamentary in nature. Therefore, no discount was Overview allowed as the FLP was ignored for estate tax purposes. In the last issue of Business Valuation Alert, the author provided a review of recent judicial decisions considering the gift and The Jorgensen Case estate tax valuation discount viability of family limited partner- One readily can see where Tax Court Judge Haines was ships (FLPs) and family limited liability companies (FLLCs). headed by a statement included in his opinion, namely, that it In addition, “factors for success” with FLPs and FLLCs were was “…especially significant that the transactions were not at outlined to encourage successful, positive planning. Now recent arms-length and that the partnerships held a largely untraded cases underscore the importance of carefully developed plan- portfolio of marketable securities.” The court did not believe ning and the necessity for monitoring FLP/FLLC plans. there was enough investment activity or that the use of the FLP was needed, other than as merely a “discounting device.” This article reviews the specifics and planning impact of two more FLP estate tax cases, namely, Estate of Erma V. Jorgensen v. Com- The author has discussed the opinion with the estate’s counsel missioner1 and Estate of Valeria Miller v. Commissioner.2 and it appears possible that significant pro-taxpayer evidence was overlooked or discarded by the court, so an appeal to the Perhaps the primary lesson to be learned in analyzing these 9th Circuit Court of Appeals is possible. new cases is that each FLP/FLLC case is unique, not only by reason of varying facts but also due to the individual Tax Court 1. Facts Are Important. Col. Jorgensen, a lawyer and career U.S. judge’s evaluation of case specifics and developed views on Air Force pilot, directed the family’s financial affairs. He gradu- estate tax issues involved. ally and carefully built up over a $2 million marketable securities portfolio. Gerald Jorgensen and his wife, Erma, were residents While in neither of the recent Tax Court cases was valuation an of Virginia and had two children and six grandchildren. issue at trial, business valuation appraisers can learn from these The thrust of the first of two FLPs, which was established cases about the key factors considered important in determin- in 1995, was to develop a plan that would allow for annual ing whether the pass-through entity—an FLP, FLLC or even gift transfers of partnership interests to the Jorgensen chil- an S corporation—will be respected for estate tax purposes. dren and grandchildren. And, in point of fact, in the first Respecting the entity is what brings into play the “fair market FLP, “discounting” was not even a goal! value” determination of entity equity interests rather than only Col. Jorgensen died in 1996, and thereafter, in advising Erma valuing the entity’s underlying assets. on her estate planning, two different lawyers emphasized valu- ation discounts. Their letters, which left unsaid many points In both Jorgensen and Miller, the FLP(s) owned principally mar- apparently, were obtained by the IRS through discovery pro- ketable securities. While in Jorgensen, two separate FLPs failed ceedings. Judge Haines seemed to input to Erma Jorgensen and to achieve estate tax recognition, the court in Miller recognized her family the lawyers’ suggestions, rather than to concentrate the initial set of contributed assets to the FLP as resulting in a on Erma herself and her motivations for the partnerships. 35 percent valuation discount from net asset value (NAV); and CONTINUED ON PAGE 8 7
  8. 8. JULY 2009 Estate Tax Cases the FLP’s securities (about 40 hours per week!). The “driving force” in 2002 behind the formation and funding of the FLP was CONTINUED FROM PAGE 7 to continue the long-standing “charting stocks” methodology of the predeceased husband, who died in 2002. The second partnership, formed by Erma following her hus- band’s death, was intended to track securities in a different way, IRS did not challenge the claimed 35 percent valuation especially as to income tax basis. Yet the court believed that a discount for the FLP entity interests, both for initial 2002 second entity was unnecessary, pointing to Erma’s living trust as gift tax purposes (8 percent equity transferred 2 percent to a vehicle for asset management. Query: Is not the taxpayer gen- each of four children) and estate tax purposes. However, erally free to select among legally available entity alternatives, after decedent broke her hip and rapidly appeared to develop provided no entity is set up solely for tax avoidance purposes? other health problems, the rush of the family in May of 2003 2. The Tax Court Analysis. First of all, the court refused to to transfer all of decedent’s remaining securities to the FLP grant the estate’s motion to shift the burden of proof under was suspect. Here the court stated the “driving force” of Code Section 7491 to IRS on the fact issues in dispute. Judge this transfer was to reduce the taxable estate of decedent. Haines merely discarded 7491, indicating he would look at Therefore, no discount was allowed. the burden of persuasion. Yet it appears the court failed in its opinion to take into account evidence (including testimony) There was another issue in the Miller case, namely, whether as to the bona fide nature of the FLPs, the family’s motive a marital deduction trust established by the predeceased to share wealth among family members, and the lack of husband must be included in the surviving spouse’s estate concern about valuation discounts in the first FLP. even when she received no income distributions during her Judge Haines dealt with the litany of non-tax reasons for remaining lifetime, presumably not needing the income. the FLPs as suggested by the estate’s counsel. This was done Citing the Soberdash case4 and discussing the scope and in the context of determining whether the “bona fide sale” requirements of the QTIP (qualifying terminable interest exception to application of Code Sec. 2036(a) was available property) trust election, the court made clear that the right to the estate. Section 2036(a) brings back into the estate to income was what was important, not whether it was lifetime transfers of property (here the marketable securi- taken or needed by the surviving spouse. Therefore, the ties contributed to the FLPs) where the transfers essentially court included the value of the QTIP trust in the surviving are testamentary in nature. Citing the well-known Bongard spouse’s estate at her date of death. case,3 the court stated that the bona fide sale exception is available “…where the record establishes the existence What Is the Future of FLP/FLLC Planning? of a legitimate and significant nontax reason for creating Tax practitioners and business valuation appraisers ask this the FLP and the transferors received partnership interests question all the time. The answers depend on: proportionate to the value of the property transferred.” A careful review of the case indicates that Judge Haines did 1. Your evaluation of pass-through entity planning as a wealth not believe the family members were credible witnesses and preservation technique; and also that he perhaps gave too much weight to the amount of 2. Your guess as to the future of the estate tax law (generally) and investment activity that gives substance to the FLP. This taxpayer Treasury efforts to reign in valuation discounts (specifically). loss in Tax Court is softened by the more reasonable approach taken in the Miller case, the latest in the now long line of judicial The author’s article in the last issue of Business Valuation Alert decisions on FLP/FLLC viability for estate tax purposes. provided some insights into viable planning, but also cautioned readers to follow legislative developments carefully, especially in light of the present bill in Congress for valuation discounts The Miller Case to be restricted severely.5 Once again, an FLP was involved here, in which two separate sets of marketable securities contributions by the decedent to Those interested in the valuation process and in using valuation the FLP took place—one around the time of FLP formation in principles to benefit families should review all the alternatives 2002 and the other in 2003 shortly prior to decedent’s death. available in estate planning. Certainly, planning with active business entities offers many opportunities, including those Tax Court Judge Goeke, in considering the “bona fide sale” excep- relating to valuation. tion to Section 2036(a), approved the partnership plan as having nontax significance and stated: “MFLP’s activities need not rise Differentiating between compensation entitlements and busi- to the level of a ‘business’ under the Federal income tax laws in ness equity interests can “divide” business value. The use of order for the exception under section 2036(a) to apply.” co-tenancy valuation discounts, long accepted by the courts, can be useful where real estate is involved. However, where The court found the testifying family members at trial to be cred- passive assets are to be held by an entity and gifts or sales ible—especially Virgil G. Miller, the eldest son who managed made within the family, this author suggests a cautious, well- 8 © 2009 CCH. All Rights Reserved
  9. 9. JULY 2009 documented approach, taking into account these two recent End Notes 1 cases as well as the “factors for success” presented in the Jorgensen v. Comm’r, T.C. Memo. 2009-66 (3/26/09). 2 previous article. FLP/FLLC planning most likely will remain Miller v. Comm’r, T.C. 2008-128 (5/27/09). 3 viable, but perhaps at greater risk and cost. Estate of Bongard v. Comm’r, 124 TC 95 (2005); see also, Estates of Stone, T.C. Memo. 2003-309. 4 Owen G. Fiore, JD, FioreWealthPlanningConsulting, is a past Estate of Soberdash v. Comm’r, T.C. Memo. 1997-362. 5 contributor of BV Alert. His non-lawyer consulting practice 5 H.R. 436, the “Pomeroy Bill,” introduced January, 2009. Section regularly involves valuation issues and the use of entities and 4 thereof proposes substantial restrictions on passive investment en- techniques to preserve wealth. For more information (as well tity valuation discounts and also restrictions on minority discounts as to obtain copies of regular newsletters on these and other where a family (with broadly determined attribution of ownership) topics), go to Owen’s Web site at www.owenfiore.com. ◆ has control of the entity. ASB Adopts New Disclosure Requirements for 2010– 2011 Edition of USPAP At its public meeting in New Orleans, The Appraisal Foun- ered prior to accepting an assignment, disclosure must be made dation’s Appraisal Standards Board (ASB) adopted revisions whenever the prior relationship is discovered. The disclosure for the next edition of the Uniform Standards of Professional requirement applies to report certification. Appraisal Practice (USPAP). The revised edition of USPAP will be in effect for two years, starting January 1, 2010 and New Disclosure Requirement Necessary ending December 31, 2011. for Preserving Public Trust “We understand this new obligation may be unpopular While the 2010-2011 edition of USPAP is scheduled to be avail- with some appraisers,” says Sandra Guilfoil, Chair of the able on October 1, 2009, the ASB is recommending that appraisers ASB. She adds that the ASB is doing its best to provide and their clients familiarize with the upcoming changes as soon as guidance regarding the new requirement which the ASB possible. To facilitate this early education, the ASB has released believes to be necessary for securing public trust in the Summary of Actions Related to Proposed Changes, a document appraisal profession. that outlines and explains the upcoming changes to USPAP. In a current climate with a focus on things like transparency in ASB Highlights Two Changes financial transactions,” says Guilfoil, “the ASB did not believe The ASB is highlighting two of the most significant chang- that USPAP was adequately serving public trust by allowing an es to USPAP. One of these two changes is the elimination appraiser to complete an assignment without initially notifying of the requirement for appraisers to allow clients access the client of any recent involvement with the property,” to work files when preparing a Restricted Use Appraisal Report. The ASB decided that this Ethics rule statement In addition to the Summary of Actions Related to Proposed is unnecessary because of the existing requirement that Changes document, the ASB released a series of Q&As on the all appraisal reports contain sufficient information to en- topic for additional guidance. The Q&A clarifies confidential- able the intended users of the appraisal to understand the ity issues and other concerns. “We encourage appraisers and report properly. users of appraisal services to read through the Summary of Actions now, and thoroughly familiarize themselves with the The second change the ASB anticipates will be more controversial. requirements well in advance of the January 1, 2010 effective Under the 2010-2011 edition of USPAP, in the Conduct section date,” says Guilfoil. of the Ethics Rule, appraisers will be obligated to notify clients of any involvement with the subject property within the prior three The Summary of Actions Related to Proposed Changes (April 3, years. The obligation covers services in regards to property as an 2009) can be accessed at The Appraisal Foundation’s Web site: appraiser or in any other capacity, such as property management, www.appraisalfoundation.org/Summary_of_Actions_2010- leasing, brokerage, auction, or investment advisory services. 11_USPAP. The USPAP Q&A (Vol. 11, No. 4, April 2009) on the new disclosure requirement is available here: www. Appraisers must provide this disclosure up front, prior to ac- appraisalfoundation.org/s_appraisal/bin.asp?SID=1&DID=1 cepting an assignment. If the prior involvement is not discov- 351&CID=12&VID=2&DOC=File.PDF. ◆ 9
  10. 10. JULY 2009 Impairment Testing grouped, the following excerpt from EITF 02-7 outlines when to test indefinite-lived assets individually and when to test CONTINUED FROM PAGE 1 them as a group: of the reporting unit would be compared to the adjusted A.Indicators that two or more indefinite-lived intangible as- carrying value of the reporting unit. sets should be combined as a single unit of accounting for impairment testing purposes: Essentially, the impairment amount cascades sequentially ■ The intangible assets were purchased in order to construct through various individual and groups of assets before it finally or enhance a single asset (i.e., they will be used together). results in the quantification of the goodwill impairment. ■ Had the intangible assets been acquired in the same ac- quisition they would have been recorded as one asset. ■ The intangible assets as a group represent the highest and Impairment Testing of best use of the assets (e.g., they yield the highest price if sold Indefinite-Lived Assets as a group). This may be indicated if (a) it is unlikely that a substantial portion of the assets would be sold separately or Indefinite-lived assets consist largely of trademarks, brands, (b) the sale of a substantial portion of the intangible assets and other similar intangible assets whose life is deemed to individually would result in a significant reduction in the be uninhibited by legal, regulatory, contractual, competitive, fair value of the remaining assets as a group. economic or other factors. ■ The marketing or branding strategy provides evidence that the intangible assets are complementary, as that term is The testing of indefinite-lived assets is the simplest and most used in paragraph A16 of Statement 141. straight-forward of the various asset impairment tests, and B.Indicators that two or more indefinite-lived intangible assets is covered in SFAS No. 142. The test involves comparing should not be combined as a single unit of accounting for the fair value of the asset with its carrying value. If the fair impairment testing purposes: value is less than the carrying value, the asset is impaired by ■ Each intangible asset generates cash flows independent of any the difference. other intangible asset (as would be the case for an intangible asset licensed to another entity for its exclusive use). Testing Criteria ■ If sold, each intangible asset would likely be sold sepa- Indefinite-lived assets are tested for impairment annually rately. A past practice of selling similar assets separately or more frequently due to an event. SFAS No. 142 refers is evidence indicating that combining assets as a single to SFAS No. 144 for examples of events or changes in unit of accounting may not be appropriate. circumstances that may cause companies to consider in- ■ The entity has adopted or is considering a plan to dispose terim impairment testing. The listing is provided below of one or more intangible assets separately. and is considered illustrative, though not exhaustive or ■ The intangible assets are used exclusively by different comprehensive: Statement 144 asset groups. ■ The economic or other factors that might limit the useful a. A significant decrease in the market price of the asset. economic life of one of the intangible assets would not b. A significant adverse change in the extent or manner in similarly limit the useful economic lives of other intan- which the asset is being used or in its physical condition. gible assets combined in the unit of accounting. c. A significant adverse change in legal factors or in the busi- ness climate that could affect the value of an asset, including Impairment Testing of Long- an adverse action or assessment by a regulator. d. An accumulation of costs significantly in excess of the Lived Assets amount originally expected for the acquisition or construc- tion of an asset. Long-lived assets consist largely of PP&E, customer e. A current-period operating or cash flow loss combined with relationships, technology, trademarks, and other similar a history of operating or cash flow losses or a projection or intangible assets. forecast that demonstrates continuing losses associated with the use of the asset. Impairment testing of long-lived assets is a multi step process: f. A current expectation that, more likely than not, the asset will be sold or otherwise disposed of significantly before ■ Step 1 is a recoverability test that is based on a comparison the end of its previously estimated useful life. of company specific projections of undiscounted cash flows with the carrying value of the assets; Indefinite-lived assets are generally tested individually for ■ Step 2 is a comparison of the fair value of the assets with impairment. However, while rate EITF 02-7 does allow their carrying value; and, for indefinite-lived assets which meet certain criteria to be ■ Step 3 is a calculation of individual asset impairment. 10 © 2009 CCH. All Rights Reserved
  11. 11. JULY 2009 Testing Criteria Figure 1 Long-lived assets are tested only when events or changes in circumstances occur and potentially cause them to be impaired. A listing of events or ASSET GROUP changes in circumstances provided in SFAS No. 144 is provided below. This list is illustrative, though not comprehensive: a. A significant decrease in the market price of GOODWILL PP & E TRADEMARK CUSTOMER TECHNOLOGY (if asset group a long-lived asset (asset group). RELATIONSHIPS = b. A significant adverse change in the extent reporting group) or manner in which a long-lived asset (as- set group) is being used or in its physical condition. c. A significant adverse change in legal factors or in the busi- For purposes of this Statement, impairment is the condition ness climate that could affect the value of a long-lived asset that exists when the carrying amount of a long-lived asset (asset group), including an adverse action or assessment by (asset group) exceeds its fair value. An impairment loss a regulator. shall be recognized only if the carrying amount of a long- d. An accumulation of costs significantly in excess of the lived asset (asset group) is not recoverable and exceeds amount originally expected for the acquisition or construc- its fair value. The carrying amount of a long-lived asset tion of a long-lived asset (asset group). (asset group) is not recoverable if it exceeds the sum of the e. A current-period operating or cash flow loss combined with undiscounted cash flows expected to result from the use a history of operating or cash flow losses or a projection or and eventual disposition of the asset (asset group). That forecast that demonstrates continuing losses associated with assessment shall be based on the carrying amount of the the use of a long-lived asset (asset group). asset (asset group) at the date it is tested for recoverabil- f. A current expectation that, more likely than not, a long- ity, whether in use (paragraph 19) or under development lived asset (asset group) will be sold or otherwise disposed (paragraph 20). An impairment loss shall be measured as of significantly before the end of its previously estimated the amount by which the carrying amount of a long-lived useful life. asset (asset group) exceeds its fair value. Over the past six to nine months, many companies have expe- Step 1: Testing the Assets for Recoverability rienced a triggering event, resulting in an increase in the need for impairment testing of long-lived assets. In Step 1, the assets are tested for recoverability. This involves comparing the undiscounted cash flows of the asset group with Testing Methodology its carrying value. There are several key inputs in completing The structure of the testing of long-lived assets is a controver- the undiscounted cash flow test: sial issue—many valuers believe (View 1) that assets are ag- CONTINUED ON PAGE 12 gregated (regardless of whether they are tangible or intangible assets) and tested at the lowest level for which identifiable Figure 2 cash flows are largely independent of the cash flows of other groups of assets and liabilities. COMPANY While others believe (View 2) that the FASB only meant for PP&E assets to be grouped while intangible assets should be tested indi- vidually, as cash flows relating to intangible assets can be identi- fied (similar to the approach used in a purchase price allocation) and therefore represent the lowest levels of cash flows. REPORTING UNIT 1 REPORTING UNIT 2 Our interpretation of the guidance is consistent with the former and, as such, it is our belief that assets should be grouped at the lowest level of independent cash flows and that the asset group can include both tangible and intangible assets. ASSET ASSET ASSET ASSET GROUP GROUP 1 GROUP 2 GROUP 3 Impairment testing of long-lived assets is a multi step process. Paragraph 7 of SFAS No. 144 describes impairment as follows: 11
  12. 12. JULY 2009 Impairment Testing undiscounted cash flows. For instance, in determining the fair value there is no cap on the life of the asset/asset group. CONTINUED FROM PAGE 11 Rather, the life is based on the market participant’s assump- tions about the asset/asset group’s life. In many cases, the ■ The projected cash flows include all expected cash inflows asset group is a business, and thus, the cash flows extend and outflows that are directly related to the asset group and out into perpetuity. which are expected to arise as a direct result of the use and eventual disposition of the assets. Calculating the fair value of the asset/asset group can be more ■ Cash flow projections, including the recovery of assets at the end straightforward than calculating the undiscounted cash flows. of the projection period. This typically includes working capital In many cases, the assumptions used to determine the fair value and PP&E but may also include recovery of intangible assets. are more objective and easier to determine. For instance, in ■ Cash flows are projected over the remaining useful life of Step 1 certain costs, such as R&D expense, may need to be the primary depreciated or amortized asset. This is typically excluded as they relate to future products other than assets be- the most important asset of the business. In certain situations ing tested for impairment. A second area of uncertainty relates where the most important asset is not being depreciated or to determining the value and, therefore, the cash flow related amortized, the next most important asset is utilized. to a non-core intangible (such as a trademark or customer ■ A fairly common adjustment to the company’s base cash relationships) at the end of the remaining useful life of the flow projections is related to R&D expenses. R&D expenses primary asset/asset group. are typically related to future product generations and, as such, are not directly associated with the use and disposition If the fair value is below the carrying value of the asset/asset of the asset group. group the impairment is then allocated to the individual assets ■ The carrying value of the assets can include or exclude in the next step. goodwill. If a reporting unit only has one asset group (see reporting unit 1 in Figure 2), goodwill is included Step 3: Determining the Impairment of Individual Assets in the asset group. If on the other hand, a reporting unit (see reporting unit 2 in Figure 2) consists of multiple If, in Step 1, the asset/asset group is determined to be not asset groups, goodwill is not included in the carrying recoverable (CV>undiscounted cash flows) and in Step 2 value of the asset groups. the asset group is impaired (CV>FV), then the impairment amount needs to be allocated to the individual assets of the Table 1 summarizes the recoverability test on the various asset asset group. This process is iterative, as the minimum value groups of Reporting Unit 2. for any asset is its fair value. The impairment indicated can be less than the difference between the fair value and the carrying Step 2: Determining the Fair Value of the Asset/Asset Group value of the assets. If, in Step 1, it is determined that the carrying value of the as- In this situation, the assets will only be written down on a pro-rata set/asset group is not recoverable, the next step is to calculate basis to the level of impairment indicated by the fair value of the the fair value. group. The fair value of any individual asset is its floor value. The fair value is determined consistent with SFAS No. 157, In other situations, the impairment indicated is greater than and as such, the asset group value may be higher than the the difference between the fair value and the carrying value. This excess (or incremental impairment amount) could Table 1 potentially result in goodwill impairment. Table 2 pro- Reporting Unit Undiscounted Carrying Conclusion vides an example of this calculation. Cash flow Value The fair value of the asset group is $50, while the car- Asset Group 1 $60 $50 No impairment rying value is $60. Allocating on a pro-rata basis results Asset Group 2 $70 $130 Impairment indicated, in an impairment of fixed assets by an amount greater proceed to fair value test than the fair value of the fixed assets allow. Thus, the Asset Group 3 $30 $60 Impairment indicated, impairment is re-allocated to other assets. proceed to fair value test Total $160 $240 Goodwill Impairment Testing Goodwill $160 Unallocated as the asset groups are Goodwill impairment testing is a two-step test at the components of the reporting unit level and is performed after testing of all reporting unit other assets is complete. The fair value of the reporting 12 © 2009 CCH. All Rights Reserved
  13. 13. JULY 2009 unit is calculated and compared to the Table 2 carrying value to determine if impairment Asset Group Book % of Fair Pro –Rata Allocation Adjusted Book exists. If the fair value is less than the 3 Value Total Value Allocation of Value carrying value, further calculations are impairment required in order to determine the fair Working $10 n/a 0 0 $10 value of goodwill. Capital Fixed Assets 20 40% 18 4 2 18 The level of testing for goodwill impair- ment is somewhat controversial. Some valuers (View 1) believe that Step 1 of Customer 10 20% 12 2 0 10 goodwill impairment testing should be relationships completed at a total asset or enterprise Technology 20 40% 7 4 8 12 value level, while others (View 2) believe that Step 1 of goodwill impairment testing Total 60 10 10 50 should be completed at the equity level. While there are a number of arguments on either side, it is our belief that the including goodwill.....If the fair value of a reporting enterprise value level is most appropriate because it is more unit exceeds its carrying amount, goodwill of the objective in determining whether or not asset impairment reporting unit is considered not impaired, thus the is indicated. Testing at the equity level may be skewed by second step of the impairment test is unnecessary. If negative equity or by complications in the determination of the carrying amount of a reporting unit exceeds its the value of equity after consideration of the fair value of fair value, the second step of the goodwill impair- debt without reflection of the ability to adhere to specific ment test shall be performed to measure the amount payment terms. of impairment loss, if any. Testing Criteria The fair value is determined consistent with SFAS No. 157. SFAS No. 142 requires companies to test for impairment an- In addition, the value of the reporting unit should consider (as nually or more frequently if an event occurs or circumstances per EITF 02-13) whether the reporting unit would be sold in change that would more likely than not reduce the fair value a taxable or non-taxable transaction. of a reporting unit below its carrying amount. The indicators noted are as follows: This calculation is fairly complex and will likely require assistance from the company’s tax department in order a. A significant adverse change in legal factors or in the busi- to determine if any incremental value would arise from ness climate. structuring the sale of the reporting unit in a taxable or b. An adverse action or assessment by a regulator. non-taxable transaction. There is a debate whether this c. Unanticipated competition. is within the scope of services provided by the valuation d. A loss of key personnel. professional. e. A more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or In the current economic environment, the equity of many otherwise disposed of. companies is trading at values below their carrying values f. The testing for recoverability under Statement 144 of a (i.e., their market capitalization is below the carrying value significant asset group within a reporting unit. of their book equity). While this is not an absolute indication g. Recognition of a goodwill impairment loss in the financial state- that goodwill impairment exists, it is a significant identifier ments of a subsidiary that is a component of a reporting unit. that goodwill impairment may exist whether the test is com- pleted at the equity or enterprise value level. As part of this issue, companies, valuers, and auditors have seen a renewed Testing Methodology discussion of control premiums. For example: Step 1: Identifying Potential Impairment ■ Does the market capitalization reflect the fair value of a The excerpt below from paragraph 19 of SFAS No. 142 high- company? lights the Step 1 test: ■ What if the company consists of multiple reporting units? ■ Does the market value of a company’s equity reflect the 19. The first step of the goodwill impairment test, fair value of debt or the obligation related to debt from the used to identify potential impairment, compares the perspective of equity holders? fair value of a reporting unit with its carrying amount, CONTINUED ON PAGE 14 13
  14. 14. JULY 2009 Impairment Testing The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the CONTINUED FROM PAGE 13 implied fair value of goodwill. The fair value of assets and liabilities are calculated in These are all questions that need to be addressed in arriving a manner consistent with SFAS No. 157. In addition, at a fair value conclusion for the reporting unit(s) being tested EITF 02-13 also needs to be considered, as the fair value for impairment. Many times these questions are answered of goodwill should reflect any adjustment of deferred through additional calculations such as the comparison of tax (assets or liabilities) in determining the fair value of reporting units’ values to market-based values, including the goodwill. Similar to other assets and liabilities whose fair review of current and historical control premiums in order to values are being determined, revised estimates of deferred determine reasonableness. taxes are calculated only for the purpose of determining goodwill impairment. Step 2: Determining the Fair Value of Goodwill The excerpt below from paragraph 20 and 21 of SFAS No. Summary of Impairment Tests 142 highlights the Step 2 test: SFAS Nos. 142 and 144 together provide a comprehensive 20. The second step of the goodwill impairment test, framework for testing the various long-lived and indefinite used to measure the amount of impairment loss, com- lived assets for impairment. Table 3 provides a summary of pares the implied fair value of reporting unit goodwill each asset type, applicable accounting standard, frequency of with the carrying amount of that goodwill. If the car- testing and other pertinent information. rying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss In addition to the primary guidance documents noted above, shall be recognized in an amount equal to that excess. there are other factors such as SFAS No. 157, EITF 02-7, The loss recognized cannot exceed the carrying amount EITF 02-13, auditor guidance/ perspective and the SEC’s of goodwill. perspective that need to be considered in completing the impairment tests. 21. The implied fair value of goodwill shall be deter- mined in the same manner as the amount of goodwill The current financial and economic environment contin- recognized in a business combination is determined. ues to have a significant impact on companies and their That is, an entity shall allocate the fair value of a re- financial statements. Many companies have taken sizeable porting unit to all of the assets and liabilities of that impairments of goodwill, intangible assets and PP&E and unit (including any unrecognized intangible assets) as will continue to review company assets, on a quarterly if the reporting unit had been acquired in a business basis, with numerous levels of management coupled with combination and the fair value of the reporting unit various advisors. was the price paid to acquire the reporting unit.14. PJ Patel, CFA, ASA, is Senior Table 3 Vice President and Partner at Valuation Research Corporation Asset Type Indefinite-lived Long-lived Tangible & Goodwill (VRC). He leads VRC’s financial Intangible Assets Intangible Assets reporting related valuations practice and speaks regularly Accounting SFAS 142 SFAS 144 SFAS 142 Guidance on financial reporting related valuation issues. He is an active Focus Indefinite-lived Test the recoverability Goodwill carried at member of the AITF and is cur- Intangible assets of finite-lived assets lower of FV or CV rently on the Appraisal Founda- carried at lower of FV tions working group developing or CV best practices for valuing cus- Methodology One step Multiple steps Two step tomer relationships. For more information (including archived Frequency Annually/event based Event based Annually/event based webcasts) please visit www.valu- ationresearch.com. ◆ 14 © 2009 CCH. All Rights Reserved
  15. 15. JULY 2009 Calendar AUGUST NACVA. The National Association of Certified Valuation Analysts is offering a Business Valuation and Certification ASA. The American Society of Appraisers is offering the Training Center on September 14–19 in San Francisco, courses The Market Approach and Valuation of Intangible CA and on September 21–26 in Chicago, IL. Contact: Assets for Financial Reporting Purposes from August NACVA, 1111 Brickyard Road, Suite 200, Salt Lake City, 13–16 at the Double Tree Hotel and Conference Center, UT 84106-5401; call 800-677-2009 or 801-486-0600; or Chicago North Shore, Skokie, IL. Contact: American Soci- fax 801-486-7500. ety of Appraisers Headquarters, 555 Herndon Pkwy, Suite www.nacva.com 125, Herndon, VA 20170; call (800) ASA-VALU. www.appraisers.org IBA. The Institute of Business Appraisers is offering the courses Essentials of Business Appraisal on Sep- NACVA. The National Association of Certified Valuation tember 21–25, Business Appraisal Review Accreditation Analysts is offering a Business Valuation and Certification Workshop on September 22–26, Report Writing, Review Training Center on August 10–15 in Philadelphia, PA and on & Analysis on September 23–24, and Preparation for August 17–22 in Milwaukee, WI. Contact: NACVA, 1111 the CBA Written Exam on September 26, at the Palmer Brickyard Road, Suite 200, Salt Lake City, UT 84106-5401; House Hilton Hotel, Chicago, IL. Contact: IBA, P.O. call 800-677-2009 or 801-486-0600; or fax 801-486-7500. Box 17410, Plantation, FL 33318; call 954-584-1144; www.nacva.com or fax 954-584-1184. www.go-iba.org AICPA. The American Institute of Certified Public Ac- countants is offering the AICPA National Business Valu- ation School on August 17–21, Lewisville, TX. Contact: AICPA Member Service Center, Conferences, 220 Leigh OCTOBER Farm Road, Durham, NC 27707-8110; call 888-777-7077; ASA. The American Society of Appraisers is offering the or fax 800-870-6611. courses CAVSMC—Monte Carlo Simulation: Extensions www.cpa2biz.com/conferences in Valuation Part I on October 17, CAVSRO Real Options Valuation: Extensions in Value Part II on October 18, CAVS123R—CAVS123R/409A on October 21-22, and SEPTEMBER CAVSCC—Cost of Capital on October 21–22, at the Boston Marriott Copley Place, Boston, MA. The ASA ASA. The American Society of Appraisers is offering the is also offering the courses The Income Approach and courses Introduction to Business Valuation and Business Introduction to Business Valuation from October 1–4 at Valuation Case Study from September 10–13 at the Loews the Manhattan Beach Marriot, Manhattan Beach, CA. Annapolis Hotel, Annapolis, MD. Contact: American Soci- Contact: American Society of Appraisers Headquarters, ety of Appraisers Headquarters, 555 Herndon Pkwy, Suite 555 Herndon Pkwy, Suite 125, Herndon, VA 20170; call 125, Herndon, VA 20170; call (800) ASA-VALU. (800) ASA-VALU. www.appraisers.org www.appraisers.org AICPA. The American Institute of Certified Public Ac- NACVA. The National Association of Certified Valuation countants is offering the AICPA National Forensic Account- Analysts is offering a Business Valuation and Certification ing Conference on September 23–25, San Francisco, CA. Training Center on October 26–31 in New Orleans, LA. Contact: AICPA Member Service Center, Conferences, 220 Contact: NACVA, 1111 Brickyard Road, Suite 200, Salt Leigh Farm Road, Durham, NC 27707-8110; call 888-777- Lake City, UT 84106-5401; call 800-677-2009 or 801-486- 7077; or fax 800-870-6611. 0600; or fax 801-486-7500. www.cpa2biz.com/conferences www.nacva.com 15

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