Special Valuation Situations
| Author | Russell L. Parr |
| Profession | President of Intellectual Property Research Associates |
| Pages | 155-173 |
CHAPTER 12
SPECIAL VALUATION SITUATIONS
Previous chapters introduced valuation methodologies and providedexamples that illustrate
them. Most of those examples represent situations that arise in the normal course of busi-
ness. This chapter discusses the application of those methodologies to situations involving
purchase piece allocation, bankruptcy, and ad valorem taxes.
PURCHASE PRICE ALLOCATION
When an acquisition is completed, all of the assets must be valued. Generally Accepted
Accounting Principles (GAAP) promulgated by the Financial Accounting Standards Board
(FASB) require that the purchase price be allocated among the monetary assets, tangible
assets, intangible assets, and intellectual property acquired. Accounting Standards Codi-
cation (ASC) 820: FairValue Measurements and ASC 805: Business Combinations provide
guidance.
ASC 820. ASC 820 states, “Fair value is 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.”
• Fair value is based on the highest and best use of the acquired property. This might
be different from the value of an asset under its current management or use.
• Orderly transaction means that the property is well understood by the buyer and
seller and a reasonable amount of time is available for making a transaction.
Tounderstand highest and best use, think of real estate. A neighborhood is going through
change. It has become popular among Millennials. In this neighborhood, there is a property
being used as a recycling center (junkyard). As a junkyard, it has a certain value, but as the
location for a new high-rise apartment building, it has an entirely different and higher value.
Trademarks can provide another example. A trademark in the hands of a online business
would have a valueof, say, $100 million, but if acquired by a business that has both an online
business and a well-oiled distribution network with extensive contacts in brick-and-mortar
stores, the value could be signicantly higher.
What about when the acquirer obtains a trademark as part of the acquisition but plans to
use its own trademark for the combined ongoing business? Even if the acquired trademark
is “parked,” it had value at the time of the acquisition, and this value must be accounted for
in the purchase price allocation.
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156 Ch. 12 Special Valuation Situations
Also, consider software. An acquiring company buys a target company that sells a suc-
cessful software product on a standalone basis. It has a certain value based on its standalone
revenues and prots, but the acquirer has its own software product into which the acquired
software can be integrated, enhancing the buyer’s product and allowingfor a higher selling
price (and prots). The acquiring company has two avenues of exploitation, and the
acquired software is typically valued on the basis of its new exploitation potential.
ASC 850. ASC 805 describes the accounting treatment an acquirer should use in business
combinations. It recognizes assets acquired and liabilities assumed at fair value as dened
in ASC 820. ASC 805 denes business combination as “A transaction or other event in
which an acquirer obtains control of one or more businesses.” It denes a business as “an
integrated set of activities and assets that is capable of being conducted and managed for
the purpose of providing a return.” A business is an organized structure that takes inputs,
performs activities on the inputs, and generates an output, all by the generation of reasonable
return on investment.
The fundamental goal of purchase price allocation is the allocation of the purchase price
to all of the acquired assets on their fair values. The purchase price is the total provided
to the seller. It can include cash, stock, and the assumption of any liabilities. It can also
include contingent payment where the acquirer is required to make future payments, most
often based on future performance of the acquired business. Often, when the process is
complete, any residual amount of the purchase price not allocable to the total of all acquired
assets is categorized as goodwill.
The essence of purchase price allocation is to identify the proceeds paid to the seller and
allocate the amount among everything obtained for the purchase price.
Acquisition Price =Cash +Stock +Liabilities Assumed +Contingent Payments
The value of cash, stock, and assumed debt is not usually difcult. Determining the value
of contingent payments can be challenging. Payment of them is dependent on the achieve-
ment of certain milestones such as a revenue or earnings target. The value is dependent
on the probability of hitting the targets and on the risk involved. Management projections
of the specic target on which the contingent payments are based are the foundation for
determining the value of the contingent payments. Several scenarios may be projected,
each indicating a different value for the contingent payments. The different values must
be weighted based on a portability of the different scenarios. ASC 805-30-35 states that
“changes resulting from events after the acquisition date, such as meeting an earnings tar-
get, reaching a specied share price, or reaching a milestone on a research and development
project, are not measurement period adjustments.”
GOODWILL. Goodwill represents the future economic benets from exploitation of all
acquired assets, which has not met the criteria for being individually identiable, sep-
arately recognized, and individually valued. As discussed in Chapter 3, businesspeople,
attorneys, accountants, and judges have all had a try at dening this most intangible of intan-
gibles. Many equate goodwill with patronage, or the proclivity of customers to return to a
business and recommend it to others. This results from superior service, personal relation-
ships, advertising programs, and business policies that meet with favor in the marketplace.
Another common aspect of a goodwill denition is the presence of “excess earnings.” That
is, a business that possesses signicant goodwill is likely to have earnings that are greater
than earnings required to provide a fair rate of return on the other assets of the business.
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