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Fair Value for Healthcare Entities’ Financial Reporting. Decosimo Advisory Services Shannon Farr, CPA•ABV•CFF. Objectives. Identify the various standards and standard-setting bodies involved in fair value determinations for healthcare entities
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Decosimo Advisory Services
Shannon Farr, CPA•ABV•CFF
Identify the various standards and standard-setting bodies involved in fair value determinations for healthcare entities
Understand the differences between fair value and fair market value – and the circumstances in which each applies
Discuss the variety of circumstances healthcare entities encounter requiring a fair value or fair market value determination
Accounting for acquisitions – understand the purchase price allocation process
Identify specific intangible assets commonly found in healthcare organizations and methods of valuing those assets
Evaluate recent guidance on contingent consideration
Understand the GAAP impairment requirements and order of testing regarding long-lived assets; goodwill; and specifically-identified, indefinite-lived intangible assets
One of these is not a real organization, set of standards, or credential – do you know which?
All entities preparing GAAP financial statements
The price that would be received to sell an asset
paid to transfer a liability
in an orderly transaction
between market participants
at the measurement date.
the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.
The fair market value standard typically applies in a healthcare transaction. Stark Regulation 420 CFR 411.351 defines FMV as follows:
…the value in arms-length transactions consistent with the general market value. ‘General market value’ means the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party; or the compensation that would be included in a service agreement as a result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party, on the date of acquisition of the asset or at the time of the service agreement. Usually, the fair market price is the price at which bona fide sales have been consummated for assets of like type, quality, and quantity in a particular market at the time of acquisition, or the compensation that has been included in bona fide service agreements with comparable terms at the time of the agreement, where the price or compensation has not been determined in any manner that takes into account volume or value of anticipated or actual referrals. With respect to rentals and leases described in §411.357(a), (b), and (l), “fair market value” means the value of rental property for general commercial purposes (not taking into account its intended use).
Healthcare Fair Market Value (regulatory compliance):
Acquisitions of healthcare entities,
Physician on-call and coverage arrangements,
RVU-based compensation arrangements,
Medical director service agreements,
Management services contracts between physicians and hospitals,
Clinical co-management arrangements, and
Joint ventures and “under arrangements.”
FASB Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures
Goodwill impairment – ASC Topic 350, Intangibles – Goodwill and Other (formerly SFAS No. 142)
Purchase price allocation – ASC 805, Business Combinations (formerly SFAS No. 141R)
Stock issued as compensation – ASC 718, Compensation – Stock Compensation
Note: While originally excluded from the requirements of SFAS Nos. 141 and 142, ASC 958 (formerly SFAS No. 164) extends the business combination and annual goodwill impairment testing requirements to not-for-profit entities for fiscal years beginning after December 15, 2009.
Physician medical groups – after 10 or so years, hospitals and integrated delivery systems have been returning as buyers of physician practices:
Source: Irving Levin Associates, Inc., The Health Care Services Acquisition Report, Seventeenth Edition, 2011)
Now includes not only cash and value of equity issued to the seller at closing, but also the fair value of any “contingent consideration”
“The contingent consideration of $10.6 million recorded during 2010 is related to agreements to pay additional amounts based on the achievement of certain performance measures for up to five years ending after the acquisition dates. The accrued contingent consideration for each acquisition was recorded at acquisition-date fair value using the income approach with assumed discount rates ranging from 3.0% to 6.0% over the applicable terms and an assumed payment probability of 100% for each of the applicable years. The range of the undiscounted amount the Company could pay under the contingent consideration agreements is between $0 and $12.1 million.”
It is capable of being separated from the entity and sold, transferred, licensed, rented or exchanged, either individually or with a related contract, identifiable asset, or liability (regardless of whether there is intent to do so)
It arises from contractual or other legal rights
Marketing-related: trademarks or tradenames, internet domain names
Patient-related: patient lists or files, referral relationships
Contract-based: non-compete agreements, payor contracts, employment contracts, certificates of need, provider numbers, Joint Commission accreditation, management agreements, lease agreements
Technology-based: proprietary technology, patents or formulas
Workforce-in-place is always considered part of goodwill
Although the value of the acquired entity’s assembled workforce is always recorded as part of goodwill, it is useful to estimate the value of the assembled workforce and consider that value in relation to the concluded value of goodwill (in other words, the total assigned to goodwill should be at least equal to the value of the assembled workforce).
The value includes factors such as: the cost to recruit, hire and train new employees of comparable experience and expertise
The value is typically estimated as a percent of total compensation for various classifications of employees (i.e. the % of compensation used in the cost estimate related to employee-physicians and registered nurses will be higher than that used for receptionists and clerical personnel).
Typically used for the primary (i.e. the perceived most important specifically-identified intangible asset acquired in the deal).
Involves estimating an income or cash flow stream and an appropriate discount rate reflecting the risk of the cash lows
The most important consideration:
The measure of economic income (cash flows) used in the valuation of an intangible asset must relate only to income generated by the subject intangible asset
Which begs the question: how are cash flows from a specific intangible asset isolated?
The answer: contributory asset charges
The measure of economic income used in the valuation of an intangible asset must relate only to income generated by the subject intangible asset.
For example, the primary specifically-identified intangible asset in many deals is a certificate of need. However vital to the success of the acquired entity, a certificate of need must be accompanied by other assets, such as working capital, necessary equipment, and a trained and assembled workforce.
To determine the value of the primary intangible asset, first determine the value of the other intangibles, then compute contributory asset changes to isolate cash flows from the primary asset.
Noncompete agreements restricting the former owners of an entity from competing within the local market are commonly seen in healthcare transactions
Certain legal restrictions may inhibit enforceability
The value of a noncompete agreement can be determined based on two factors:
1. The likelihood that the former owner(s) would compete in the absence of the agreement, and
2. The percentage or dollar amount of future revenues that would be lost to that competition.
All else being equal, a certificate of need acquired through an acquisition in a state or market designated as sufficiently covered (i.e. new certificates of need for that service are not anticipated in the future) will be more valuable than a certificate of need acquired in an area allowing new entrants to compete in the market.
FACTS and CIRCUMSTANCES must be considered
Calculating the tax amortization benefit associated with each identified intangible asset
The excess of purchase price over the values assigned to all identified assets and liabilities is goodwill
Estimating the useful lives of identified intangible assets
Comparing the Weighted Average Return on Assets (WARA) to the Weighted Average Cost of Capital (WACC)
Goodwill and identified intangible assets with indefinite lives must be evaluated annually for impairment
Goodwill is tested for impairment at least annually using the two-step test prescribed in ASC 350
However, a recent Accounting Standards Update (ASU) allows a “Step Zero” qualitative assessment
the entity is required to proceed to Step 1 of the goodwill impairment test
A reporting unit is defined as an operating segment or one level below (also known as a component)
A component of an operating segment would be considered a reporting unit if it is 1) a business, 2) has discrete financial information, and 3) segment management routinely reviews that financial information
Components that share similar economic characteristics are aggregated
or the liability relates to
The operations of the RU
If debt or other liabilities are assigned to the RU, decreasing the carrying value (and the potential for impairment)
the settlement of that debt or other liabilities must be reflected as a reduction of cash flows in determining the fair value of the reporting unit
Discounted cash flow (DCF) method
Guideline public company method
Guideline transaction method
Associated with risks facing the RU
Determined with consideration to qualitative factors similar to those outlined by the ASU allowing the Step Zero assessment
Represents the long-term growth of net cash flow
Must consider the positive effects of increased demand due to the aging population offset by pressure on profits due to decreasing reimbursement rates
Very unlikely to exceed long-term anticipated growth of GDP as a whole (around 2.5% - 3%)
Uses information from acquisitions of comparable companies
Generally considered of limited use in healthcare valuations because of the relatively extreme differences in local and/or state markets in which healthcare entities operate
The GPC uses information on multiples of similar publically-traded companies to derive a value for the reporting unit
Especially useful for hospitals, home health care, and ambulatory surgery centers
Determine which multiples are the most relevant
Evaluate whether adjustments to the GPC financial metrics are necessary
Apply selected multiples to the RU financial metrics
Consider whether a control premium is necessary
The assets and liabilities (existence and value) booked in the past are useful but not determinative
Unrecorded assets and liabilities of the RU may exist
The value of identified intangible assets may have changed
Deferred tax impacts need to be considered
The FV of the reporting unit less the FV (not the book value) of all RU assets and liabilities at the valuation date = the implied value of goodwill
Is the implied value of goodwill greater than or less than the RU’s recorded goodwill?
If less than, the difference between = an impairment loss
AF – the Appraisal Foundation
USPAP – Uniform Standards of Professional Appraisal Practice
ASA – Accredited Senior Appraiser of the American Society of Appraisers
IRC – Internal Revenue Code (Rev. Ruling 59-60)
FASB – Financial Accounting Standards Board
CPA – Certified Public Accountant
ABV – Accredited in Business Valuation
CFA – Chartered Financial Analyst
ASC – Accounting Standards Codification
ASU – Accounting Standards Update
CBA – Certified Business Appraiser
MCBA – Master Certified Business Appraiser
AVA – Accredited Valuation Analyst
AVC– If you chose this one, you were right!
CM&AA – Certified Merger and Acquisition Advisor
HFMA – Healthcare Financial Management Association
AICPA – American Institute of Certified Public Accountants
ABA – American Bar Association
AHLA – American Health Lawyers’ Association
NACVA – National Association of Certified Valuation Analysts
SSVS – Statement on Standards for Valuation Services
CVA –Certified Valuation Analyst