One Word Makes All the Difference: Updates in Fair Market Value & Fair Value. June 1, 2016

Transcription

1 One Word Makes All the Difference: Updates in Fair Market Value & Fair Value Oklahoma Society of Certified Public Accountants CPE Tulsa, Oklahoma June 1, 2016 Presented by: Glenn D. Vestrat, CVA, MBA S. Christopher Lopp, CPA/ABV/CGMA, CFE, MBA

2 About HoganTaylor HoganTaylor is one of the largest CPA firms in the Oklahoma and Arkansas region with more than 200 professionals and employees, including 29 partners. HoganTaylor has offices in Oklahoma City, Tulsa, Fayetteville, and Little Rock.

3 History and Future Today Hogan & Slovacek (H&S) began helping its clients and people achieve their goals in Tulsa and Oklahoma City Tullius Taylor Sartain & Sartain (TTS&S) began in Tulsa with a mission to help its clients and people achieve their goals TTS&S expanded to serve northwest Arkansas with the opening of an office in Fayetteville January 1, 2009, these two outstanding firms merged to form one of the region's largest independent accounting firms: HoganTaylor LLP January 1, 2015, HoganTaylor LLP enters the Little Rock market to better serve its Arkansas-based clients Our combined resources allow us expanded abilities to serve new industries, to stay on the leading edge of technology and trends, and to focus on new services that add value to our clients

4 What We Do HoganTaylor is comprised of professionals who continually demonstrate they are adept at providing services that are on time and well managed to a wide range of business types and specialized industries. Accounting Solutions Advisory Services Assurance Business Valuation Employee Benefit Plans Human Capital and Organizational Strategies Litigation Support Outsourced CFO Services Risk Assurance Tax Services Wealth Management

5 Who We Serve Our focus on key industries ensures we offer our clients specialized expertise and an understanding of important industry trends and issues. Our principal industry expertise includes: Collective Trust Funds Construction Energy Financial Institutions Information Technology Services Insurance Manufacturing and Distribution Nonprofit Retail Transportation

6 Structure for Today Updates in Two Widely Used Standards of Value: Fair Market Value Business Valuations Fair Value Financial Reporting

7 Fair Market Value Defined The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. IRS Title 26, Section , Chapter 1(B)

8 References Revenue Ruling 59-60: The purpose of this Revenue Ruling is to outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes.

9 Application Court decisions frequently state, in addition, that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.

10 Typical Purposes Income tax valuations Gift Estate Inheritance taxes Charitable contributions Employee Stock Ownership Plans (ESOPs) Purchase or sale of a business

11 Standards of Value Answers the question: Value to Whom?

12 UPDATE: Risk-Free Rate Debate Risk-free rate used in estimating cost of equity capital: Can be used in a cost of capital build-up method Build-up method origins based on Capital Asset Pricing Model (CAPM) Can only be inferred for a private company Is typically equal to the 20 year U.S. Treasury yield

13 UPDATE: Risk-Free Rate Debate Consequences of the financial crisis beginning in 2008: 1. Flight to safety 2. Prices on U.S. Treasury bonds increased and yields decreased 3. At the same time, equity prices decreased 5. New normal? 4. Yield for 20 year U.S. Treasury bond decreased to 3%

14 UPDATE: Risk-Free Rate Debate

15 UPDATE: Risk-Free Rate Debate Thought leaders (such as Roger Grabowski, et al.) handle the apparent contradiction by normalizing the Risk-Free Rate Recommended Risk-Free Rate: As of January 31, 2016 = 4.0% Duff & Phelps Client Alert

16 UPDATE: Risk-Free Rate Debate in Numbers Cost of Equity Capital Build-Up Approach Spot Rate Risk-Free Rate 2.2% All Other Risk Premia 10.0% Total Cost of Equity Capital 12.2% Less: Long-Term Growth -3.0% Capitalization Rate 9.2% U.S. Treasury yield, 20 year, February 26, 2016

17 UPDATE: Risk-Free Rate Debate in Numbers Cost of Equity Capital Build-Up Approach Normalized Rate Risk-Free Rate 4.0% All Other Risk Premia 10.0% Total Cost of Equity Capital 14.0% Less: Long-Term Growth -3.0% Capitalization Rate 11.0% Duff & Phelps concluded normalized risk-free rate as of January 31, 2016

18 UPDATE: Risk-Free Rate Debate in Numbers Capitalization Example Build-Up Approach Spot Rate Annualized Cash Flow $ 100,000 Capitalization Rate 9.2% Indication of Value $ 1,086,957

19 UPDATE: Risk-Free Rate Debate in Numbers Capitalization Example Build-Up Approach Normalized Rate Annualized Cash Flow $ 100,000 Capitalization Rate 11.0% Indication of Value $ 909,091

20 UPDATE: Risk-Free Rate Debate in Numbers Capitalization Example Build-Up Approach Difference in Value Indication of Value - Spot Rate $ 1,086,957 Indication of Value - Normalized Rate 909,091 Difference in Value 177,866 Percentage difference in Value 16%

21 UPDATE: Risk-Free Rate Debate The future a continued debate a valuation is an assessment of the future as of a point in time. As such, if the valuation date is today, then you should use the current risk-free rate lower risk-free rates do not always translate into higher values for risky assets, and it is not necessarily a problem that needs to be solved. It is important to approach all the internal components and external macro-components separately and collectively in order to create the most consistent model possible. Kevin Piccolo, ASA, The Value Examiner, March/April 2012

22 Fair Value Defined Fair value is 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. ASC Topic 820, Fair Value Measurement

23 Fair Market Value Defined The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. IRS Title 26, Section , Chapter 1(B)

24 Mandatory Performance Framework The Exposure Draft incorporates the joint standards for how to perform a valuation based on those followed by: 1. American Institute of Certified Public Accountants (AICPA) Statement on Standards for Valuation Services No. 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset (SSVS No. 1) 2. American Society of Appraisers (ASA) ASA Business Valuation Standards. The Business Valuation Standards of the American Society of Appraisers are used in conjunction with the Uniform Standards of Professional Appraisal Practice (USPAP) of The Appraisal Foundation, and the Principles of Appraisal Practice and Code of Ethics of the American Society of Appraisers 3. Royal Institution of Chartered Surveyors (RICS) RICS Valuation Professional Standards incorporate the International Valuation Standards (IVS)

25 Differences in Definitions of Fair Value and Fair Market Value Fair value specifically applies to any engagement, or part of an engagement, that involves estimating the fair value of a subject interest to serve as a basis for management s preparation of financial statements for public interest reporting Fair value considers both assets and liabilities Fair value has an exit price assumption and excludes transaction costs Fair value requires the consideration of value in various markets and to different types of buyers (i.e. strategic vs. financial)

26 Fair Value of Liabilities ASC Topic 820 assumes that liabilities are transferred to a market participant as of the measurement date, and the liability continues in existence to the counterparty The present value of all of the future payments are discounted back at the market discount rate applicable to the risk of the acquired company If the company making the acquisition has a better credit rating than the company being acquired, the fair value of the liability will increase, resulting in a charge against earnings and an increase in the balance sheet value of the liability on a re-measurement date This is highly controversial, but the desire to have both sides of the transaction reporting the same value is dictating the approach

27 Exit Price Assumption Requires valuation professional to measure amount that would be received if asset were sold, or paid if liability were settled, which does not necessarily equal the transaction price For example: if you were measuring the value of a commodity position and it were an asset (long position), you would use the published bid price, but if it were a liability (short position), you would use the published ask price Assumption is debatable, especially as it relates to the measurement of the value of liabilities when lower credit ratings reduce the price to settle the liability, which, in turn, leads to paper gains as a reward for having a lower credit rating

28 Consideration of the Market Fair value must be measured in the principal market, if there is one. If there is not, then the asset or liability must be valued in the most advantageous market that the company is able to access. Principal market: the market with the greatest level of volume, or the market that the entity generally uses Transaction costs: are not factored into the final determination of fair value are considered in the determination of the most advantageous market Transportation costs: considered a deduction to fair value (i.e. costs to truck product to market or pipeline tariffs)

29 Market Example Most advantageous market - the market that maximizes the amount that would be received to sell the asset, or minimizes the amount that would be paid to transfer the liability, after taking into account transaction costs and transportation costs. Example: Blue company acquires Green company in a business combination. Green has on its balance sheet an investment in the common stock of Purple company, which is traded on the New York Stock Exchange and the Toronto Exchange as follows: Exchange Price Transaction Cost Net NYSE $40 $6 $34 Toronto $38 $2 $36 What is the fair value of the common stock of Purple?

30 Market Example Answer The fair value of the Purple common stock on Blue s balance sheet, post acquisition of Green, is: $40 if the principal market is the NYSE $38 if the principal market is the Toronto Exchange $38 if there is no principal market, as the most advantageous market is Toronto

31 Related Accounting Standards The following accounting standards are issued by Financial Accounting Standards Board (FASB), and are common subject interest topics that may be applicable when a company engages a valuation professional (not an all-inclusive list): ASC 350 Intangibles Goodwill and Other ASC 360 Property, Plant, and Equipment (specifically longlived asset impairment) ASC 606 Revenue from Contracts with Customers ASC 718 Compensation Stock Compensation ASC 805 Business Combinations ASC 820 Fair Value Measurement ASC 825 Financial Instruments ASC 946 Financial Services Investment Companies Source: Proposed Mandatory Performance Framework for the Fair Value Quality Initiative

32 Related Accounting Standards Valuation professionals should also be aware of auditing standards used by the audit profession as guidance when they conduct an audit of financial statements prepared for public interest reporting. These include, but are not be limited to: AS 1105 Audit Evidence (to supersede AS No.15) AS 1210 Using the Work of a Specialist (to supersede AU 336) AS 1215 Audit Documentation (to supersede AS No.3) AS 2501 Auditing Accounting Estimates (to supersede AU 342) AS 2502 Auditing Fair Value Measurement and Disclosure (to supersede AU 328) Source: Proposed Mandatory Performance Framework for the Fair Value Quality Initiative

33 Questions? HoganTaylor LLP Tulsa office: (918) OKC office: (405) Fayetteville office: (479) Little Rock office: (501) Disclaimer The information contained within this presentation is provided for informational purposes only and is not intended as rendering of accounting, tax, financial, or legal services. Information in these slides was intended for a specific training purpose on a specific date and may not be used or relied upon outside of the context of this training.