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.
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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.
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.