How Fair Value Could Affect Your Next Deal

Since auditors will surely give more scrutiny to the next wave of reports that evaluate the intangible assets of an acquired company, CFOs should too.
Sarah JohnsonNovember 1, 2007

CFOs will need to pay more attention to their purchase-price allocation reports the next time they’re in acquisition mode.

According to Mercer Capital, the new fair-value accounting standards going into effect for many companies this month will bring about some changes to the reports that determine the value of an acquired company’s intangible assets. FAS 157 — which provides a framework for marking value estimates to market rather than historical cost — will likely heighten the scrutiny given to the valuations of these assets, particularly from auditors and possibly regulators, according to the financial advisory firm.

Auditors’ eagle-eye treatment will likely apply even more to those assets that are thinly traded or not traded at all. Evaluations of those assets, under the so-called Level 3 category, depend on unobservable estimates based on what value the company believes a hypothetical third party would place on those assets.

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Moreover, FAS 157 creates a mind-shift on the part of companies because it emphasizes the market participant’s view rather than what a company’s own prospective plans are for a certain asset. That will mean companies will have to apply the new fair value standard to an acquired asset even if they have no desire to ever sell it or do anything with it.

Purchase-price allocation reports — put together by a valuation specialist during or sometimes after a company has been acquired — are meant for financial managers and auditors to value the acquired assets and determine goodwill for reporting purposes.

The narrative required by FAS 157 will have to address not only the company’s plans but incorporate those of the market participant, and how the valuation specialists came up with their conclusions, according to Mercer.

CFOs should also make sure the reports are easy to understand, and that they have received enough information with which to judge the valuation specialist’s judgment. For example, the report should describe the valuation approaches and methods the specialist could have used to show that he or she is knowledgeable and at least considered the other ways of coming up with the final numbers.

The Financial Accounting Standards Board’s major changes to how companies estimate fair value will likely have little bearing on an organization’s decision to acquire another company’s assets. “For most CFOs, the purchase-price allocation report is more of a compliance issue than a strategic issue,” says Travis Harms, a Mercer vice president. “Frankly, I don’t expect that to change significantly at least in the near term.”

Still, considering that it’s a necessary task, CFOs will save themselves some grief in the long run if they get involved early in the process, hire the right valuation specialist for their needs, and familiarize themselves with the report they receive, says Mercer. “Too often, managers find themselves struggling to answer 11th-hour questions from auditors or being surprised by the effect on earnings from intangible asset amortization,” wrote Harms and B. Patrick Lynch in a recent paper.

“The process will work better for CFOs, the valuation specialist, and the auditor if the allocation gets more priority in the beginning,” Harms told CFO.com. After all, he says, “CFOs are notorious for not liking surprises.”

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