In short:
- Was the pandemic a triggering event that requires your company to revalue intangibles?
Here’s how to assess. - FASB Topic 820 may be on the docket for updates. For now, be prepared to back up
assertions. - Standards bodies may also reevaluate testing goodwill for impairment.
When it comes to fair value for intangible assets, like patents or trademarks, the pandemic
has impacted everyone, but not everyone equally. One result is that companies may see an
increasing delta between their book and market values, says Mark Zyla, managing director at
Zyla Valuation Advisors and chairman of the IVSC’s Standards Review Board.
Fair value is both subjective and highly likely to be affected by volatility. That means CFOs
need to make an honest assessment of how their specific balance sheets should change. We
asked Zyla to advise.
Brainyard: Framing the pandemic as an economic event, how significant of a lasting
effect will we see on asset values, as well as regulations and other intangibles? In
short, will the new normal be very different? Who are the winners and losers?
Mark Zyla: The pandemic is acting as an accelerator of economic trends that
were likely to happen anyway. For example, we are seeing a trend toward increasing
valuations of technology-based companies, such as Amazon. The value of these companies is
comprised increasingly of intangible assets, such as unique processes and other
technologies, customer relationships, trade names and brands.
Intangible assets are becoming a more important component of the total value of an entity.
While this trend is most prominent in technology-based companies, it is occurring in other
sectors as well.
BY: You literally wrote the, or a, book on FASB’s Topic 820,
“Fair
Value Measurement.” Which pandemic-driven changes in fair value standards should
finance
teams be aware of?
MZ: The biggest issue in valuations for financial reporting caused by the
economic impact of the pandemic is whether or not certain assets of an entity —
particularly
goodwill — are impaired due to the economic downturn. The accounting standards require
testing for impairment of the fair value of these assets if a “triggering event”
occurs.
Companies should make a determination as to whether the economic impact of the pandemic is
such that it constitutes a triggering event for their business. Trigger events may include a
sustained decrease in share price of a public company; deteriorating macroeconomic and
industry conditions directly impacting the company; and declining cash flows of the company,
particularly compared with previous expectations.
Another economic consequence of the pandemic is that, as the economy continues to shift to
more technology-based companies, the value of these companies will be comprised primarily of
intangible assets. While the fair value of intangible assets is measured on financial
statements in a merger or acquisition, internally generated intangible assets are typically
not recorded. Consequently, we are likely to see larger differences in the market value of
companies as opposed to their book value. For example, according to Tagnifi, Amazon’s
price
per share is currently around 23 or 24 times its book price per share, while Zoom’s
share
price is almost at 80 times its book value.
BY: Are there other requirements that companies should
reassess?
MZ: Both the FASB and the International Accounting Standards Board (IASB)
are considering revising the model for testing goodwill for impairment from a solely
impairment test to a combination of amortization and impairment. This potential change could
have a couple of impacts on financial reporting.
First, amortization of goodwill will likely reduce reported net income. Secondly, there is a
point of view that the proposed change will not provide investors with information
that’s as
useful as the current standards provide. The benefit, however, is that the proposed change
may make the process of testing goodwill for impairment simpler and perhaps less costly for
preparers of financial statements. A mixed amortization/impairment model could reduce the
amount of testing requirements, for example.
BY: Cost versus price versus fair value — how can, for example,
an
owner of a now largely vacant New York or San Francisco commercial property navigate
these concepts?
MZ: Each of these terms represents a different concept in valuation.
Cost is what one paid for an asset, either outright or developed
internally. Price is a measure based on similar transactions in a
marketplace. Fair value is a financial reporting term of value from a
market participant perspective.
Sometimes the values from the three concepts intersect and yield the same result, but more
often, that’s not the case. Value depends upon the purpose and perspective of the use
of the
asset or entity. In times of uncertainty, the market may initially misprice the value of an
asset. The owner of an asset should fully consider the risk and return the asset is expected
to generate under current conditions. Perhaps this may involve increasing use of alternative
assumptions and probabilities in developing scenarios of forecasted financial information.
Suppose an entity has proprietary technology that is used in its product line.
Cost would be the expenses the company actually incurred to develop the
technology; price can be estimated by analyzing the terms license
agreements of similar technology; and fair value would be what other
entities would be willing to pay the developer for the technology.
BY: Which red flags will auditors look for as we hopefully move into
the recovery phase next year? Do you expect extra scrutiny on — for example,
revenue and
receivables?
MZ: I believe the biggest red flags will relate to testing for impairment of
assets. Auditors will focus on the methods and metrics management used in determining
whether the pandemic constituted a trigger event, and would therefore require a reassessment
of intangible assets. Finance leadership should utilize more robust analysis methods, such
as probability weighting scenarios, or even more sophisticated statistical analysis of
prospective financial information to provide support for their assertions.
The leadership at smaller companies should consider probability weighting scenarios of
different possible outcomes.
BY: What methods can a finance leader use to test for material changes
in value in a way that will satisfy a funder, potential buyer or auditor?
MZ: The accounting standards under ASC 820 “Fair Value
Measurements”
describe three basic valuation techniques: cost, market and income. A finance leader should
assess which method or methods under these techniques are most appropriate for a specific
asset.
For a business entity, an intrinsic method, such as a discounted cash flow analysis, and a
relative method, such as comparison to market-based transactions, are typically useful in
measuring fair value. However, whatever techniques are used, keep in mind that the
definition of “fair value” in financial reporting requires the assumptions in
the
measurement are from a “market participant” rather than the entity’s
standpoint.
Also, finance leaders should be careful that assumptions take into consideration the
uncertainty caused by current economic conditions.
BY: What M&A trends are you seeing?
MZ: Transactions are still occurring. However, in pricing a transaction,
older valuation metrics may not be appropriate under current market conditions. The pricing
analysis should be more robust given increased uncertainty of outcomes. For example,
prospective financial information may be substantially different for an entity pre- and
post-pandemic depending on their view of the effects on the business.
BY: What didn’t we ask that Brainyard readers should
know?
MZ: In addition to my practice, I currently chair the standards review board
of the International Valuation Standards Council, which is the only global,
multidisciplinary valuation standards setter. The IVSC recently issued an Agenda
Consultation seeking feedback on current valuation trends. Some of the issues we see
becoming increasingly important in valuation are the impact of environmental, social and
governance (ESG) focus on the overall value of companies. We also see the value of
internally generated intangible assets becoming more important to investors. And, the
economic impact of the pandemic has given rise to an increasing focus on uncertainty and
risk in valuation.
About Our Expert
Mark L. Zyla is a Managing Director of Zyla Valuation Advisors, LLC, an Atlanta-based
valuation and litigation consultancy firm.
Mark received a BBA in Finance from the University of Texas at Austin and an MBA with a
concentration in Finance from Georgia State University. Mark also completed the M&A
at The Wharton School and the Valuation Program at the Graduate School of Business at
Harvard University. He is a Certified Public Accountant, Accredited in Business
Valuation (“CPA/ABV”), Certified in Financial Forensics (“CFF”)
by the AICPA, a
Chartered Financial Analyst (“CFA”), and an Accredited Senior Appraiser
(“ASA”).
Mark is the Chairman of the Standards Review Board of the International Valuation
Standards Council (“IVSC”), where he recently served on the Forensic and
Valuation
Services Executive Committee. Mark is a member of the Business Valuations Committee of
the ASA. Mark is on the Advisory Council of the Master of Science in Finance program at
the University of Texas at Austin. In 2013, Mark was inducted into the AICPA Business
Valuation Hall of Fame.
Mark is a frequent presenter and author on valuation issues. He has served on the faculty
of the Federal Judicial Center and the National Judicial College. Mark is author of Fair
Value Measurement: Practical Guidance and Implementation 3nd ed. and the course,
“Fair
Value Accounting: A Critical New Skill for All CPAs” published by the AICPA. Mark
is
also co-author of several portfolios published by Bloomberg BNA.
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