SFAS 141r / 157

1. Preparing for SFAS 141R
November 12, 2008

2. 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 purposes
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 surrounding
financial reporting.
Valuation Research Corporation 2

3. 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. 157
and other emerging issues. He will be speaking on Business
Combinations on December 10, 2008 at the AICPA SEC Conference.
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4. 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.
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5. 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?
• How t account for IPR&D?
H to tf
• Post-reporting adjustments to acquisition accounting
• What is the impact of SFAS No. 157?
• Post-transaction Issues
• How to account for changes in the fair value of contingent consideration?
• How to account for IPR&D?
• Impairment testing
g
• Case Study
• Summary of Key Issues
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6. 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.
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7. 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 period
beginning on or after December 15, 2008.
• 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
Business C bi ti
B i Combination
• 04-1 – Accounting for Preexisting Relationships between the Parties to a
Business Combination
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8. 141R – Overview of Major Changes
Item
It 141 141R Impact
I t
Terminology “Purchase Method” “Acquisition Method”
Definition of A business is a self-sustaining integrated set An integrated set of activities and
a Business of activities and assets conducted and managed assets that is capable of being
for the purpose of providing a return to conducted and managed for the
investors. A business consists of (a) inputs, (b) purpose of providing a return in the
processes applied to those inputs, and (c) form of dividends, lower costs, or other
resulting outputs that are used to generate economic benefits directly to investors
revenues. For a transferred set of activities and or other owners, members, or
assets to be a business, it must contain all of participants. A business consists of
i i b i i f
the inputs and processes necessary for it to inputs and processes applied to those
continue to conduct normal operations after the inputs that have the ability to create
transferred set is separated from the transferor, outputs. Although businesses usually
which includes the ability to sustain a revenue
y have outputs, outputs are not
p , p
stream by providing its outputs to customers. required for an integrated set to
qualify as a business.
Definition of EITF No. 98-3; acquisition of process Lower threshold More entities
a Business applied to inputs to make outputs. considered
Capable of providing a return to
businesses;
Many development-stage businesses investors or dividends, lower costs or
in particular
excluded. other economic benefits.
development
stage
companies.
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9. 141R – Overview of Major Changes
Item
It 141 141R Impact
I t
Definition of Assets acquired through Transaction or other event in More transactions
Business exchange of consideration. which acquirer obtains control, considered business
Combination including share repurchase, combinations.
minority veto rights lapse,
contract alone no transfer (dual
listing, stapling arrangement).
Business Goodwill, assets based on If control is obtained, all assets Greater clarity as fair value
Combination acquired interest.
interest and liabilities are recognized at is applied consistently.
consistently
Achieved in fair value.
Stages (aka Certain ratios are changed.
If control is obtained, remeasure
“Step
previously held equity interest at
Acquisition”)
fair value, recognize gain/loss.
Noncontrolling Goodwill, assets based on Recognize at fair value. Fair Valuation of
Interest acquired interest. value and pro-rata value may noncontrolling interest
differ due to inclusion or control may be required.
premium/discount for lack of
control.
t l
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10. 141R – Overview of Major Changes
Item
It 141 141R Impact
I t
Acquisition Date Measurement date for equity Measured on date control is Uncertainty regarding value
consideration is around obtained. of equity consideration.
announcement date.
Usually closing date. Purchase accounting reflects
All other consideration at
th id ti t value on the acquisition
l th i iti
closing. date.
Transaction and Transaction costs add to cost Transaction costs expensed as Purchase price excludes
Acquisition- of business. incurred. transaction related
Related expenses,
expenses thus lower
lower.
Restructuring costs recorded Restructuring costs expensed as
d
Restructuring
as a liability. incurred unless recognizable Expenses before and after
Costs
under SFAS 146 at acquisition transaction likely higher.
date. Transaction related
restructuring considered to occur
after t
ft transaction.
ti
Contingent Generally adds to the cost of Estimate at fair value on Need to calculate fair value
Consideration an acquisition and recognized acquisition date.
i iti d t of contingent consideration
when resolved. at the transaction date and
Changes in value generally
in future periods.
recognized in earnings.
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11. 141R – Overview of Major Changes
Item 141 141R Impact
Contingent “A contingent consideration Certain contingent
Consideration arrangement in which the payments consideration may be
are automatically forfeited if compensation for
employment terminates is postcombination services
services.
compensation for postcombination
services.” A87.a.
Bargain Purchase Pro-rata reduction – “Cram Assets acquired at fair value.
Down.”
Gain in income statement.
statement
Contingent Not recognized at fair value 141R initially called for increased use
Assets and in purchase accounting. of Fair Value related to Contingent
Liabilities Assets and Liabilities.
Handled by other GAAP.
Contingent Assets not Certain groups had significant
typically recognized. concerns.
Currently, very likely no change vs.
141.
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12. 141R – Overview of Major Changes
Item
It 141 141R Impact
I t
Indemnification Recognized at same time, measured on
Asset 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. valued the same.
Amortized once completed, write-off if Subsequent accounting may
abandoned. be complex; difficult to track
specific projects.
Adjustments to One year to complete Initially, provisional amounts are Increased time pressure and
business purchase accounting recognized. earlier inclusion of valuation
combination professionals in the M&A
Adjustments reflected in Subsequently, provisional amounts revised
accounting process.
period of change in prior periods back to acquisition date.
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13. 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 date
y
• Establishes a framework for measuring fair value
• Exit price vs. entry price
• 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
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14. 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 y
assets 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
strategic buyer group ($100 $100 and $50) Alth
t t i b ($100, $100, d $50). Although th use of th assets within th strategic b
h the f the t ithi the t t i 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 70
Technology - C 50 70
TOTAL 250 190
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15. 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 p
p y y j patent infringement related litigation. The
g g
acquirer 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.
• IPR&D
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16. 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 issues will we face post-transaction?
• IPR&D
• Defensive assets
• Impairment
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17. 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 around
Stock price $2.0 $2.10 announcement date
Shares exchanged 1,000 1,000
Purchase Price $2,000 $2,100
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18. 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
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19. Changes to Asset Values
Account
A Book V l
B k Value 141 Allocation
All i 141R All
Allocation
i Comments
C
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 SFAS
Customer Relationships 0 100 100 No. 157. Values reflect
highest and best use
Technology (defensive asset) 0 0 50
of the group of assets.
IPR&D 0 150 150
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20. 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 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.
Customer Relationships
p 0 100 100 values reflect highest
Technology (defensive 0 0 50 and best use of the
asset) group of assets.
IPR&D 0 150 150
Goodwill 0 1,010 1,250 Indefinite
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21. Post-Transaction Issues
• What issues will we face post-transaction?
• IPR&D
• Defensive assets
• Impairment testing
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22. 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.
project As such the fair value of the IPR&D project is now $100
such,
million, with the change in value reflected in the income statement.
Period Fair Value Balance Sheet Income Statement
Acquisition Date
A i iti D t $150 m Purchase accounting entry
P h ti t No
N amortization, no i
ti ti impact
t
of $150 m
One Year Later $100 m Adjust BS to reflect FV of $50 m expense
$
$100 m
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23. 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 however
earnings. planned,
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.
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24. 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.142
• Step 1: compare fair value of the reporting unit to carrying value if impairment
value,
indicated proceed to Step 2
• Step 2: perform a 141-type purchase price allocation (PPA) to determine level of
goodwill impairment
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25. Summary of Key Issues
• Conceptual change in business combination rules
• OBS reflects FV at acquisition date
• M
More t
transactions qualify as a Business C bi ti
ti lif B i Combination
• Purchase Accounting Issues
• Do we value A/R, inventory and other working capital items?
• Is there an contingent consideration?
any
• Are there any defensive assets?
• Timing
• Post reporting changes to acquisition accounting requires prospective revisions
Post-reporting
of historical time periods
• Post-Transaction Issues
• I/S volatility
• Contingent assets/liabilities
• IPR&D capitalized and then amortized when project is complete or impaired if project
is discarded
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26. Contact Information
PJ Patel
ppatel@valuationresearch.com
609-243-7030
609 243 7030
Ed Hamilton
ehamilton@valuationresearch.com
609-243-7018
Valuation Research Corporation 26

27. U.S. Office Locations
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Boston, MA 02110 Milwaukee, WI 53202 San Francisco, CA 94111
617.342.7366 414.271.8662
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1 2 1800
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813-463-8510
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Cincinnati,
Cincinnati OH 45202 Ewing, NJ 08628
513.579.9100 609.452.0900
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28. International Affiliate Office Locations
Buenos Aires London Monterrey
Franklin D. Roosevelt 2445 Cloister House Antonio Gaona No. 2000-401
Piso 10 Riverside Col. Florida
Buenos Aires C1428 BOK New Bailey Street Monterrey, N.L.
Argentina Manchester, M3 5AG C.P. 64810
Mexico
Caracas Madrid
Oficina 1-3, Torre Charan, Alcalá, 265, Edificio 2
Avenida Los Mangos 28027 Madrid São Paulo
Las Delicias, Caracas 1050 Spain Rua Alvarenga 1757 Butantã
Venezuela 05509-004 São Paulo SP
Brazil
Hong Kong Melbourne
22nd Floor Siu On Centre
Floor, Level 10, 470 Collins St
10 St.
188 Lockhart Road Melbourne, Victoria 3000
Wanchai, Hong Kong Australia
Valuation Research Corporation 28