sfas141 r presentation(11.11.08)

Preparing for SFAS 141RPreparing for SFAS 141R

November 12, 2008

Valuation Research Corporation

• Formed in 1975, VRC has eight U.S. offices and eight international affiliates.

• VRC provides M & A advisory services, fairness and solvency opinions in support of corporate transactions, and valuations of intellectual property and tangible assets for financial reporting and tax purposesand tangible assets for financial reporting and tax purposes.

• VRC maintains relationships with corporations, lenders, accountants, investment banks, private equity firms, and law firms.

• VRC was instrumental in forming the Appraisal Issues Task Force (AITF), a valuation industry group that meets quarterly with representatives from the FASB, the SEC, and the PCAOB to discuss valuation issues surroundingFASB, the SEC, and the PCAOB to discuss valuation issues surrounding financial reporting.

Valuation Research Corporation 2Valuation Research Corporation

P.J. Patel, CFA

• Mr. Patel specializes in the valuation of businesses, assets and liabilities for financial reporting purposes. In particular, he has focused on the valuation of intellectual property/intangible assets such as trademarks, technology, software, customer relationships and IPR&D. He also values business interests for tax purposes.

• Mr. Patel is an active member of the AITF and is currently a member of the Appraisal Foundations Working Group, which is preparing a Practice Aid for valuing customer relationships.

• Mr. Patel is a frequent presenter on valuation issues for financial reporting purposes and has recently presented on valuation issues relating to SFAS No. 141/141R, SFAS No. 142/144, SFAS No. 157relating to SFAS No. 141/141R, SFAS No. 142/144, SFAS No. 157 and other emerging issues. He will be speaking on Business Combinations on December 10, 2008 at the AICPA SEC Conference.


Edward Hamilton

• Mr. Hamilton specializes in the valuation of businesses, assets and liabilities for financial reporting purposes. In particular, he has focused on the valuation of intellectual property/intangible assets such as trademarks, technology, software, customer relationships and IPR&D. He also values business interests for tax purposes.

• He holds a B.S. in physics from Rowan University, and an M.B.A. in finance from Temple University.


Agenda

• Major Changes in Business Combination Accounting• Purchase Accounting/Valuation Issues:

• Is it a business combination? • What is the purchase price? • How to account for transaction and restructuring costs? • How to account for contingent consideration?

H t t f IPR&D?• How to account for IPR&D?• Post-reporting adjustments to acquisition accounting• What is the impact of SFAS No. 157?

• Post-transaction Issues• Post-transaction Issues• How to account for changes in the fair value of contingent consideration?• How to account for IPR&D?• Impairment testingg

• Case Study• Summary of Key Issues


SFAS 141 vs. SFAS 141R

SFAS 141• Allocate the cost of an acquired entity to the assets acquired and liabilities

assumed based on their estimated fair values at date of acquisition • Use of fair value concepts, for example:

• Receivables - PV at current interest rates less allowances • Raw materials inventory at current replacement costs• WIP and FG inventory at selling price less cost to complete, disposition costs

and reasonable profit margin• PP&E at replacement cost

SFAS 141R• Recognizes the fair value of the assets acquired, liabilities assumed and

any noncontrolling interest with limited exceptions.y g p• All assets/liabilites at fair value with limited exceptions.

6Valuation Research Corporation

SFAS 141R - Implementation

Effective Date• Applied prospectively to business combinations for which the transaction

date is on or after the beginning of the first annual reporting perioddate is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.

• Many EITFs nullified and subsumed into the standards, including:Many EITFs nullified and subsumed into the standards, including: • 01-3 – Accounting in a Business Combination for Deferred Revenue of an

Acquiree• 02-17 – Recognition of Customer Relationship Intangible Assets Acquired in a

B i C bi tiBusiness Combination• 04-1 – Accounting for Preexisting Relationships between the Parties to a

Business Combination


141R – Overview of Major Changes

It 141 141R I tItem 141 141R Impact

Terminology “Purchase Method” “Acquisition Method”

Definition of a Business

A business is a self-sustaining integrated set of activities and assets conducted and managed for the purpose of providing a return to

An integrated set of activities and assets that is capable of being conducted and managed for thefor the purpose of providing a return to

investors. A business consists of (a) inputs, (b) processes applied to those inputs, and (c) resulting outputs that are used to generate revenues. For a transferred set of activities and

conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or

i i b i i fassets to be a business, it must contain all of the inputs and processes necessary for it to continue to conduct normal operations after the transferred set is separated from the transferor, which includes the ability to sustain a revenue

participants. A business consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not y

stream by providing its outputs to customers. p , p

required for an integrated set to qualify as a business.

Definition of a Business

EITF No. 98-3; acquisition of process applied to inputs to make outputs.

Lower threshold

Capable of providing a return to

More entities considered businesses;

Many development-stage businesses excluded.

investors or dividends, lower costs or other economic benefits.

businesses; in particular development stage companies.

Valuation Research Corporation 8



Definition of Business Combination

Assets acquired through exchange of consideration.

Transaction or other event in which acquirer obtains control, including share repurchase, minority veto rights lapse,

More transactions considered business combinations.

contract alone no transfer (dual listing, stapling arrangement).

Business Combination

Goodwill, assets based on acquired interest

If control is obtained, all assets and liabilities are recognized at

Greater clarity as fair value is applied consistentlyCombination

Achieved in Stages (aka “Step Acquisition”)

acquired interest. and liabilities are recognized at fair value.

If control is obtained, remeasurepreviously held equity interest at fair value, recognize gain/loss.

is applied consistently.

Certain ratios are changed.

Noncontrolling Interest

Goodwill, assets based on acquired interest.

Recognize at fair value. Fair value and pro-rata value may differ due to inclusion or control premium/discount for lack of

t l

Valuation of noncontrolling interest may be required.


control.



Acquisition Date Measurement date for equity consideration is around announcement date.

All th id ti t

Measured on date control is obtained.

Usually closing date.

Uncertainty regarding value of equity consideration.

Purchase accounting reflects l th i itiAll other consideration at

closing.value on the acquisition date.

Transaction and Acquisition-Related

Transaction costs add to cost of business.

Transaction costs expensed as incurred.

d

Purchase price excludes transaction related expenses thus lowerRelated

Restructuring Costs

Restructuring costs recorded as a liability.

Restructuring costs expensed as incurred unless recognizable under SFAS 146 at acquisition date. Transaction related restructuring considered to occur ft t ti

expenses, thus lower.

Expenses before and after transaction likely higher.

after transaction.

Contingent Generally adds to the cost of Estimate at fair value on i iti d t

Need to calculate fair value Consideration an acquisition and recognized

when resolved.

acquisition date.

Changes in value generally recognized in earnings.

of contingent consideration at the transaction date and in future periods.



Item 141 141R Impact

Contingent Consideration

“A contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is

Certain contingent consideration may be compensation for postcombination servicesemployment terminates is

compensation for postcombinationservices.” A87.a.

postcombination services.

Bargain Purchase Pro-rata reduction – “Cram Down.”

Assets acquired at fair value.

Gain in income statementGain in income statement.

Contingent Assets and Liabilities

Not recognized at fair value in purchase accounting.

Handled by other GAAP.

141R initially called for increased use of Fair Value related to Contingent Assets and Liabilities.

Certain groups had significantContingent Assets not typically recognized.

Certain groups had significant concerns.

Currently, very likely no change vs. 141.




Indemnification Asset

Recognized at same time, measured on same basis, as indemnified liability. If FV then FV.

IPR&D Expensed on acquisition Capitalized with an indefinite life Accounted for differently, and tested under SFAS 142.

Amortized once completed, write-off if abandoned.

valued the same.

Subsequent accounting may be complex; difficult to track specific projects.

Adjustments to business combination accounting

One year to complete purchase accounting

Adjustments reflected in period of change

Initially, provisional amounts are recognized.

Subsequently, provisional amounts revised in prior periods back to acquisition date.

Increased time pressure and earlier inclusion of valuation professionals in the M&Aprocess.


SFAS No. 157

• Defines Fair Value• 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 datey

• Establishes a framework for measuring fair value• Exit price vs. entry price• Principal/most advantageous market• Principal/most advantageous market• Use of market participant inputs rather than company-specific inputs• Fair value hierarchy – Level 1, 2 and 3 inputs• Unit of account/valuation• Assets – highest and best use• Liabilities – nonperformance risk/credit risk


Example: Assets – Highest and Best Use

Example (paragraph A7-A9)• The reporting entity, a strategic buyer, acquires a group of assets (A, B, and C) in a business combination. Asset C is technology developed by the acquired entity for its own use in conjunction with Assets A and B (related assets). The reporting entity measures the fair value of each of the ( ) p g yassets individually, consistent with the specified unit of account for the assets. The reporting entity determines that each asset would provide maximum value to market participants mainly through its use in combination with other assets as a group (highest and best use is in-use).• The fair values of Assets A, B, and C would be based on the use of the assets as a group within the t t i b ($100 $100 d $50) Alth h th f th t ithi th t t i bstrategic buyer group ($100, $100, and $50). Although the use of the assets within the strategic buyer

group does not maximize the fair value of each of the assets individually, it maximizes the fair value of the assets as a group ($250).

STRATEGIC FINANCIAL BUYER BUYER

Trademark – A 100 50

Customer relationships B 100 70Customer relationships – B 100 70

Technology - C 50 70

TOTAL 250 190


TOTAL 250 190

Case Study

• Company A buys a competitor (Company B) for ~$2 billion. • The transaction is structured as a stock deal, paid for using the acquirer’s stock.• The deal is announced on 1/1/09 and closes on 3/31/09.• In addition to the purchase price, the acquirer agrees to pay the seller an earn-

out of $400 million payable over the next 3 years if certain financial metrics are met. The selling shareholders will not be staying on with the Company.

• The company is currently subject to a patent infringement related litigation. The p y y j p g gacquirer is not indemnified for this potential liability.

• The Company has the following intangible assets:• Trademark• Customer relationships• Technology – which you plan on discarding post-acquisition because if

developed the technology cannibalize one of your existing products defensive asset.asset.

• IPR&D


Case Study

In accounting for this transaction we need to address:• Is this a business combination?• What is the purchase price?• How to account for contingent consideration?• What is the fair value of other assets and liabilities acquired? • How does SFAS No. 157 impact the valuation?• What is the value of defensive assets technology?• What is the value of defensive assets – technology?

• What issues will we face post-transaction?• IPR&D• Defensive assets• Impairment


Change in the Purchase Price

Account (in 000’s) 141 Allocation 141R Allocation Comments

Measurement Date 1/1/09 3/31/09 Reflects closing date rather than reasonable period aroundperiod around announcement dateStock price $2.0 $2.10

Shares exchanged 1,000 1,000

Purchase Price $2,000 $2,100


Change in Total Consideration

Account 141 Allocation 141R Allocation Comments

Purchase Price $2,000 $2,100 Reflects FV at acquisition date

Transaction Expenses 10 0 Transaction expenses no longer capitalized

Earn Out 0 200 Reflects FV

Contingent Liability 0 0 No longer identified under 141R

Total Consideration 2,010 2,300


Changes to Asset Values

A B k V l 141 All i 141R All i CAccount Book Value 141 Allocation 141R Allocation Comments

Working capital 250 250 200 Reflects FV of all WC items

Real Property 50 100 150 FV

Personal Property 250 300 300 FV

Trademark 0 100 100 FV as a group consistent with SFASNo. 157. Values reflect Customer Relationships 0 100 100highest and best use of the group of assets.Technology (defensive asset) 0 0 50

IPR&D 0 150 150


141 vs. 141R Allocation Summary

Account Book Value 141 Allocation 141R Allocation Comment

Purchase Price $2,000 $2,100 Reflects FV at closing Date

Transaction Expenses 10 0 Expense immediatelyTransaction Expenses 10 0 Expense immediately

Earn Out 0 0 200 FV

Contingent Liability 0 0 0

Total Consideration 2,010 2,300

Working capital 250 250 200 FV

Real Property 50 100 150 FV based on principal marketplace

Personal Property 250 300 300 FV

Trademark 0 100 100 FV as a group consistent with SFAS No. 157. values reflect highestCustomer Relationships 0 100 100 values reflect highest and best use of the group of assets.

p

Technology (defensive asset)

0 0 50

IPR&D 0 150 150


Goodwill 0 1,010 1,250 Indefinite

Post-Transaction Issues

• What issues will we face post-transaction?• IPR&D• Defensive assets• Impairment testing


Post-Transaction – IPR&D

One year post-acquisition, the outcome of the IPR&D project is still incomplete. However management is now less optimistic about the project As such the fair value of the IPR&D project is now $100project. As such, the fair value of the IPR&D project is now $100 million, with the change in value reflected in the income statement.

Period Fair Value Balance Sheet Income Statement

A i iti D t $150 P h ti t N ti ti i tAcquisition Date $150 m Purchase accounting entry of $150 m

No amortization, no impact

One Year Later $100 m Adjust BS to reflect FV of $100 m

$50 m expense$


Post-Transaction – Defensive Assets

One year post-acquisition, the outcome of the Company has met its revenue and earnings targets and remains optimistic about the growth and earnings The technology was discarded as planned howeverand earnings. The technology was discarded as planned, however since the Company passes the step 1 recoverability test under SFAS No. 144, the asset remains on the Company’s balance sheet and continues to be amortized.


Impairment Testing

• SFAS No.144• Finite lived Assets:

• PP&E, amortizable intangibles (including defensive assets)• Look at undiscounted cash flows of the asset group to determine if impairment

exists• Determine FV of the asset group to determine level of impairment. Write down

assets on a pro-rata basis to reflect impairment amount with the minimum value of any asset being its fair value

• SFAS No.142• Indefinite lived assets:

• trademarks, IPR&D while incomplete• Fair value to carrying value test

• Goodwill – indefinite-lived SFAS No.142Step 1: compare fair value of the reporting unit to carrying value if impairment• Step 1: compare fair value of the reporting unit to carrying value, if impairment indicated proceed to Step 2

• Step 2: perform a 141-type purchase price allocation (PPA) to determine level of goodwill impairment


Summary of Key Issues

• Conceptual change in business combination rules• OBS reflects FV at acquisition date

M t ti lif B i C bi ti• More transactions qualify as a Business Combination

• Purchase Accounting Issues• Do we value A/R, inventory and other working capital items?

Is there an contingent consideration?• Is there any contingent consideration?• Are there any defensive assets?

• Timing• Post reporting changes to acquisition accounting requires prospective revisions• Post-reporting changes to acquisition accounting requires prospective revisions

of historical time periods

• Post-Transaction Issues• I/S volatilityI/S volatility

• Contingent assets/liabilities• IPR&D capitalized and then amortized when project is complete or impaired if project

is discarded


Contact Information

PJ [email protected] 243 7030609-243-7030

Ed [email protected]


U.S. Office Locations

Boston101 Federal StreetBoston, MA 02110

Milwaukee330 East Kilbourn Avenue Milwaukee, WI 53202

1 2 1 8662

San Francisco50 California Street , Suite 3050San Francisco, CA 94111

1 2 1800617.342.7366

Chicago200 W. Madison Street Chicago, IL 60606

414.271.8662

New York500 Fifth Avenue New York, NY 10110

415.277.1800

Tampa777 S. Harbour Island Blvd.Tampa, FL 33602Chicago, IL 60606

312.957.7500

Cincinnati105 East Fourth Street Cincinnati OH 45202

,212.983.3370

Princeton200 Princeton Corporate Center

813-463-8510

Cincinnati, OH 45202513.579.9100

Ewing, NJ 08628609.452.0900


International Affiliate Office Locations

Buenos Aires Franklin D. Roosevelt 2445Piso 10

LondonCloister HouseRiverside

MonterreyAntonio Gaona No. 2000-401Col. Florida

Buenos Aires C1428 BOKArgentina

Caracas Oficina 1-3, Torre Charan,

New Bailey StreetManchester, M3 5AG

MadridAlcalá, 265, Edificio 2

Monterrey, N.L.C.P. 64810Mexico

Avenida Los MangosLas Delicias, Caracas 1050 Venezuela

Hong Kong22nd Floor Siu On Centre

28027 Madrid Spain

MelbourneLevel 10 470 Collins St

São PauloRua Alvarenga 1757 Butantã05509-004 São Paulo SP Brazil

22nd Floor, Siu On Centre188 Lockhart RoadWanchai, Hong Kong

Level 10, 470 Collins St.Melbourne, Victoria 3000Australia


sfas141 r presentation(11.11.08)

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