Presentation on theme: "Fair Value for Healthcare Entities’ Financial Reporting"— Presentation transcript:
1Fair Value for Healthcare Entities’ Financial Reporting Decosimo Advisory ServicesShannon Farr, CPA•ABV•CFF
2Shannon Farr CPA•ABV•CFF Valuation Manager | firstname.lastname@example.org Shannon Farr is a valuation manager with more than 15 years of accounting experience. Her practice has focused on business valuation and litigation support since She is accredited in business valuation (ABV) and also certified in financial forensics (CFF).Shannon provides valuation services to clients in a wide variety of industries, with a focus on healthcare entities. Her specialized expertise in this area assists hospital and health system clients in ensuring their acquisitions meet industry regulations surrounding the concepts of fair market value and commercial reasonableness. Shannon also performs fair value for financial reporting valuations to be used in purchase price allocations and goodwill impairment testing.
3ObjectivesIdentify the various standards and standard-setting bodies involved in fair value determinations for healthcare entitiesUnderstand the differences between fair value and fair market value – and the circumstances in which each appliesDiscuss the variety of circumstances healthcare entities encounter requiring a fair value or fair market value determinationAccounting for acquisitions – understand the purchase price allocation processIdentify specific intangible assets commonly found in healthcare organizations and methods of valuing those assetsEvaluate recent guidance on contingent considerationUnderstand the GAAP impairment requirements and order of testing regarding long-lived assets; goodwill; and specifically-identified, indefinite-lived intangible assets
4Alphabet Soup: Valuation Credentials and Authoritative Standards and Bodies AFMCBAUSPAPAVAIRCAVCASACM&AAFASBAICPACPANACVAABVSSVSCFACVAASCOne of these is not a real organization, set of standards, or credential – do you know which?ASUCBA
5Fair Value for Financial Reporting Applications in Healthcare Who?All entities preparing GAAP financial statementsWhat?Purchase price allocations (acquisitions): how much did you pay? And, what did you get?Goodwill impairment: Is it still worth it?Stock-based compensation: what are these shares I’m issuing to employees and executives worth?
6What is Fair Value? Fair value is The price that would be received to sell an assetorpaid to transfer a liabilityin an orderly transactionbetween market participantsat the measurement date.
7Healthcare Fair Market Value IRS definition (applies to transactions and agreements of nonprofit entities)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.
8“Healthcare” Fair Market Value (FMV) The fair market value standard typically applies in a healthcare transaction. Stark Regulation 420 CFR 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 § (a), (b), and (l), “fair market value” means the value of rental property for general commercial purposes (not taking into account its intended use).
9One of these things is not like the other… Healthcare Fair Market Value (regulatory compliance): Acquisitions of healthcare entities, Physician-employment agreements, 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.”
10Or are they?The Stark Law “general market” concept is very similar to the FASB’s “market participant” conceptSo what does that mean?Fair value and “healthcare fair market value” are both determined without regard to a specific buyer’s synergies
11Fair Value GAAPFASB Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and DisclosuresGoodwill 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 CompensationNote: 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.
12Physician Medical Group Announced Mergers and Acquisitions Market ParticipantsPhysician 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)Physician Medical Group Announced Mergers and AcquisitionsYearTotal DealsHospital Deals200852152009411220106323
13Market Participants, continued Home health care – of 43 announced deals during 2010:12 publicly-traded corporations announced 26 deals10 privately-held and 7 nonprofit organizations announced 1 deal apiece: these organizations were hospitals, senior care companies, and one private equity group.Laboratory, imaging, and dialysis – of announced deals:11 publicly-traded corporations announced 24 deals11 privately-held and 4 nonprofit organizations announced 1 deal apiece (1 privately-held company made 2 acquisitions)21 imaging deals comprised 51% of the total followed by laboratory services (14 deals/34%) and dialysis (6 deals/15%)
16What is the Purchase Price? Now includes not only cash and value of equity issued to the seller at closing, but also the fair value of any “contingent consideration”
17Contingent Consideration What is “contingent consideration”?An obligation of the acquirer to transfer additional assets or equity interest to the selling shareowners of a target if specified future events occur or conditions are metCommonly referred to as “earn outs”SFAS 141R (ASC 805) – recognize fair value at acquisition, remeasure as new information becomes availableRemeasurement is required at every balance sheet dateHow is fair value at acquisition determined?Probability distribution of the outcomesOption pricing methods
18Contingent Consideration For acquisitions completed prior to 2009:Payments of contingent consideration (earnouts) are recorded typically as an increase to goodwill when paid (or conditions are met)For recent acquisitions (new guidance)The fair value of the earnout provisions must be determined as of the closing date and recorded with the acquisition
19Contingent Consideration In theory, the amount that would be paid to a market participant to assume the contingent consideration liability must be determined.In practice, a valuation model must be tailored to each contingent consideration agreement considering the specified:performance metrics,measurement periods,performance hurdles, andpayment terms.
20A Real-life ExampleThe following disclosure is made by MedNax (formerly Pediatrix) in Note 6, Business Acquisitions, to its 2010 financial statements, as part of its discussion of its 2010 acquisitions of 15 physician group practices:“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.”
21PPA: What Did you Buy? Working capital assets, net of liabilities Potential issues in determining the fair value of accounts receivable, if acquiredFixed assetsNeed a fixed asset appraisal of significant land, buildings, and equipment acquiredIdentifiable Intangible AssetsGoodwill
22What is an Identifiable Intangible Asset? 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)ORIt arises from contractual or other legal rights
23Identifiable Intangibles Common in Healthcare Marketing-related: trademarks or tradenames, internet domain namesPatient-related: patient lists or files, referral relationshipsContract-based: non-compete agreements, payor contracts, employment contracts, certificates of need, provider numbers, Joint Commission accreditation, management agreements, lease agreementsTechnology-based: proprietary technology, patents or formulasWorkforce-in-place is always considered part of goodwill
24Approaches to Measuring the Fair Value of Identified Intangible Assets The Cost ApproachBased on the economic principle of substitution: the value of the intangible asset is the estimated cost to either purchase or construct an asset of equal utilityThe Market ApproachThe value of the intangible asset is estimated by identifying and analyzing the price at which similar assets have been exchanged between willing buyers and sellersThe Income ApproachThe value of the intangible asset is equal to the present value of the expected income to be earned form the ownership of the asset
25Approaches and Techniques to Measuring the Fair Value of Identified Intangible Assets The Cost ApproachReplacement cost methodReproduction cost methodThe Market ApproachRelief from royalty methodComparable transactions methodThe Income ApproachThe profit split method (25% Rule)The excess earnings methodLoss of income (scenario) methodMulti-period excess earnings method
26Assembled WorkforceAlthough 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 expertiseThe 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).
27The Income Approach: Discounted Cash Flows 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 lowsThe 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 assetWhich begs the question: how are cash flows from a specific intangible asset isolated?The answer: contributory asset charges
28Contributory 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.
29Noncompete Agreement Valuation Example Noncompete agreements restricting the former owners of an entity from competing within the local market are commonly seen in healthcare transactionsCertain legal restrictions may inhibit enforceabilityThe 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, and2. The percentage or dollar amount of future revenues that would be lost to that competition.
32Common Sense Always Applies 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
33Other Purchase Price Allocation Issues Calculating the tax amortization benefit associated with each identified intangible assetThe excess of purchase price over the values assigned to all identified assets and liabilities is goodwillEstimating the useful lives of identified intangible assetsComparing 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
35Goodwill Impairment Testing Basics Goodwill is tested for impairment at least annually using the two-step test prescribed in ASC 350However, a recent Accounting Standards Update (ASU) allows a “Step Zero” qualitative assessment
36The Step-Zero Impairment Assessment Qualitative factors for management to consider prior to the performance of the two-step impairment test include the following:Macroeconomic conditions: a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates;Industry conditions: a deterioration in the market in which an entity operates, increased competition, a decline in market-dependent multiples or metrics, or a regulatory or political development;Cost factors: increases in raw materials, labor, or other significant costs;Overall financial performance: negative or declining cash flows;Entity-specific events: changes in management or key personnel, changes in strategy, contemplation of bankruptcy, litigation issues, etc.
37The Step Zero Assessment If qualitative assessment indicates that “it is more likely than not” that the fair value of a reporting unit is less than its carrying amount,the entity is required to proceed to Step 1 of the goodwill impairment test
38The Two-Step Goodwill Impairment Test (ASC 350) Step 1 – identify potential impairment by comparing the fair value of a reporting unit to the carrying value of that reporting unitNew guidance on evaluating reporting units with negative carrying amounts (e.g., debt has been assigned to the RU): an entity cannot assume goodwill is not impairedStep 2 – if goodwill is potentially impaired, recognize and measure the amount of the impairment loss
39Reporting Unit (RU) Identification 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 informationComponents that share similar economic characteristics are aggregated
40Reporting Unit Assets and Liabilities Assets and liabilities must be thoughtfully assigned to one or more (in the case of shared assets) reporting units considering both of the following criteria:The asset will be employed in,or the liability relates toThe operations of the RUANDThe asset or liability will be considered in determining the fair value of the reporting unit
41What Does that Mean?If debt or other liabilities are assigned to the RU, decreasing the carrying value (and the potential for impairment)THENthe 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
42Common Techniques used to Measure the Fair Value of the RU Discounted cash flow (DCF) methodGuideline public company methodGuideline transaction method
43DCF Key Inputs Prospective financial information (PFI) Discrete period cash flow (often 3 to 5 years)Terminal cash flowsDiscount rateLong-term growth rate
44Prospective Financial Information Incorporate Recent DevelopmentsFuture infrastructure requirementsHealthcare reform effects on revenue“New era” impacts on profitability
45Discount Rate Associated with risks facing the RU Determined with consideration to qualitative factors similar to those outlined by the ASU allowing the Step Zero assessment
46Long-term Growth Rate 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 ratesVery unlikely to exceed long-term anticipated growth of GDP as a whole (around 2.5% - 3%)
47Guideline Transaction Method Uses information from acquisitions of comparable companiesGenerally considered of limited use in healthcare valuations because of the relatively extreme differences in local and/or state markets in which healthcare entities operate
48Guideline Public Company Method The GPC uses information on multiples of similar publically-traded companies to derive a value for the reporting unitEspecially useful for hospitals, home health care, and ambulatory surgery centers
50Applying GPC Multiples Determine which multiples are the most relevantEvaluate whether adjustments to the GPC financial metrics are necessaryApply selected multiples to the RU financial metricsEvaluate resultsConsider whether a control premium is necessary
51Form the Step 1 Conclusion What fair values are indicated by the various techniques employed? (Note: GAAP requires the application of all applicable methods)How does the determined fair value of the RU compare to its carrying value?If the fair value exceeds the carrying value, there is no need to proceed to Step 2If the carrying value of the RU exceeds the indicated fair value, proceed to Step 2
52Step 2The assets and liabilities (existence and value) booked in the past are useful but not determinativeUnrecorded assets and liabilities of the RU may existThe value of identified intangible assets may have changedDeferred tax impacts need to be considered
53Step 2, continuedThe 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 goodwillIs the implied value of goodwill greater than or less than the RU’s recorded goodwill?If less than, the difference between = an impairment loss
54Alphabet Soup: Valuation Credentials and Authoritative Standards and Bodies AF – the Appraisal FoundationAVA – Accredited Valuation AnalystUSPAP – Uniform Standards of Professional Appraisal PracticeAVC– If you chose this one, you were right!CM&AA – Certified Merger and Acquisition AdvisorASA – Accredited Senior Appraiser of the American Society of AppraisersHFMA – Healthcare Financial Management AssociationIRC – Internal Revenue Code (Rev. Ruling 59-60)FASB – Financial Accounting Standards BoardAICPA – American Institute of Certified Public AccountantsCPA – Certified Public AccountantABA – American Bar AssociationABV – Accredited in Business ValuationAHLA – American Health Lawyers’ AssociationCFA – Chartered Financial AnalystNACVA – National Association of Certified Valuation AnalystsASC – Accounting Standards CodificationSSVS – Statement on Standards for Valuation ServicesASU – Accounting Standards UpdateCBA – Certified Business AppraiserCVA – Certified Valuation AnalystMCBA – Master Certified Business Appraiser