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FINANCIAL REPORTING PURCHASE PRICE ALLOCATION

Southeast Appraisal
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Frankly speaking, we have seen too many fixed asset accounting systems, and as a generalization, they are mostly “bad”. From the largest to the smallest companies they are insufficient in how much data they can store and in what fields, how the data can be manipulated and used for management and reporting information purposes, and how they reflect the assets that are actually in use and in place. This is somewhat understandable. Fixed asset accounting is not a very exciting subject. Just think, how much did you really learn about the subject in an accounting, finance or MBA program? Also, often the employee with the lowest skill level in the accounting department is given the task of both entering the data and maintaining the system, without adequate training in procedures or information applications. This results in a flawed system from the onset, and/or loss of informational accuracy over time. But this is slowly changing. Due to the reporting and review requirements of SFAS 141/142/157 and Sarbanes-Oxley, companies are now taking fixed accounting somewhat more seriously (remember in a stock purchase before the old fixed asset data was simply moved over onto the acquirer’s books). Businesses are interested in having the data actually reflect what is out there, i.e., contributing to the revenue stream. Dreaming on, some day the base data may actually be the same as on the tax books of the company, and perhaps even be the same data used for property tax reporting (the latter may occur 20 years in the future). This article offers thoughts on the implementation of a fixed asset system resulting from a financial reporting purchase price allocation. It discusses the process from the first telephone call received, through the analysis and valuation process, to the data uploading and system maintenance. The information is somewhat general in nature since each company differs in their objectives and their ideas of how such a system should fulfill their specific accounting, operational and other informational needs. THE INITIAL ANALYSIS Usually the call to the appraiser goes like this, “Good Morning…..we just purchased XYZ Company and we need to have the assets appraised for financial reporting purposes.” An exploratory meeting is then scheduled. On the telephone, but optimally at a meeting, the appraiser should discuss the objectives and requirements of the engagement by asking at least the following questions: 1. Why do you want to have the assets appraised? 2. Are specific intangible assets also to be appraised? 3. Who is being asked to do the tangibles and/or the intangibles? 4. Will there likely be goodwill remaining after all the identifiable tangible and intangible assets are valued? Or is it a bargain purchase where there will be no goodwill, and in fact the tangible and intangible assets will be “squeezed down” to reflect economic obsolescence and/or negative goodwill. 5. How much confidence do you have that the current asset record reasonably reflects the assets that are in the facility? 6. Do you care about the structure and accuracy of the new fixed asset record? 7. What fixed asset software are you using? 8. What data fields are available and how many positions are in each field? 9. Can the current fixed asset file be downloaded / converted into an Excel file? 10. Please let me see the fixed asset system hard copy and the data file in Excel? 11. What do the codes mean? 12. What is captured in the cost of each asset, i.e., freight, labor, taxes, etc.? 13. What is the historic capitalization policy and what do you want it to be in the foreseeable future? 14. Were the values of the assets adjusted by a prior purchase price allocation?  If so, do you have the last data file prior to the allocation entries? 15. Does the system identify assets that were purchased new or used, or constructed “in house”? 16. How are the capital leased assets treated in the system, and are they identified? 17. What ancillary benefits do you wish to get out of this work effort, i.e., general asset control, insurance values, property tax info, asset control data, financing, future sale, etc.? 18. There may be more questions or issues that will surface during the completion of the allocation appraisal. THE DATA PROCESSING SYSTEM This article is not meant to be a review of the available systems, but there seem to be a number of minimum criteria for an adequate system. These are as follows: 1. PC based 2. Data section that contains the basic company and location identifiers 3. Asset descriptive section that contains the following: o Asset reference number, perhaps a tag or machine number o Photograph number, if available (this is a good idea) o Base asset descriptive information, 30 characters at least o Extended description, perhaps 252 characters or more o Manufacturer o Vendor / Distributor o Contact and telephone number of salesperson (wish item) o Model number o Serial number o Year originally manufactured o Year of major rebuilds o Asset suffix capability to link assets within a line or installation, yet control each asset by suffix individually o Optional data fields 4. Financial data section that contains the following: o Original cost (what the asset cost new when originally purchased, retain this always if available) o Historic cost (the cost as entered on the books) o Purchased new or used o Allocated cost, identified as such, perhaps by repetitive dates of acquisition in the record o Optional data fields specific to the user RESPONDING TO THE USERS NEEDS The requirements of users vary. At one end of the spectrum is the manager who accepts the data in the current system as reasonably accurate and wants to get through the valuation process as inexpensively and easily as possible.  On the other end is the manager who wants to truly control the assets, not only from an accounting perspective but also from a management information perspective. Either is right and appropriate, as well as all shades and variations in between. Based on the answers to the questions posed above, the valuer identifies the specific needs of the user. To assure the valuer has correctly “read” the user’s wishes a presentation should be made confirming the allocation valuation procedures, with the positives/negatives, and options stated. After discussion, a specific engagement letter should be written so there is not any misunderstanding of the scope, procedures and deliverables resulting from the assignment. WORKING WITH THE AVAILABLE DATA Suppose the base data is truly “bad”, listing a specific machine, as just “machine tool”. As such, there is no way to figure out by physically inspecting the plant what asset is identified on the fixed asset record. If the manager says to accept the asset record as appropriately reflecting the assets of the company, the appraiser can only “trend and bend” (see following section on this phrase) the asset values. Depending somewhat on the vintage of the assets, the trite saying “junk in, junk out” may apply in this case. But, the old asset record may reasonably reflect the costs, and the asset record although not being detailed, may reasonably reflect the right values. Yet suppose the user recognizes the shortcomings of the existing system and data, and wants a new factually based system that truly reflects the assets found in the facility. In this case the old fixed asset data is essentially thrown out and a new physical inventory of the assets is completed. Specific assets over the capitalization level of the user are individually scheduled and appraised, with assets under this threshold level being grouped as a category (thereby not missing any of the asset value). This process is perceived by some users as an opportunity to create an accurate new fixed asset data system, removing all the old and perhaps inaccurate information (a fresh start without there being any cost, how nice). Many users are in between, they want to “trend and bend” the minor assets but physically look for, verify and value individually the major assets (those of high dollar levels). It is this appraiser’s opinion that this is the minimum that should be done, thereby demonstrating reasonable thoroughness and accuracy for audit and third party review (think of Sarbanes-Oxley and SFAS 141 at this moment). “TREND AND BEND” Appraisers, particularly those that work / worked for the larger independent appraisal firms or major accounting firm’s appraisal departments, use the term “trend and bend.” Simply stated, the appraiser “trends” the original cost of an asset, using the date of original manufacture, by indexing this cost data for inflation to derive a current value. This amount is then depreciated from an appraiser’s perspective to reflect the current depreciated replacement cost new.  With an assumption of adequate economic support (considering intangible asset value) this amount may be equated to the Fair Market Value. This process is not as easy as it sounds. The appraiser should consider the following: Aforementioned statements of new or used, allocated, capital lease entry, etc. What is in the original cost data as noted above, freight, labor, engineering, design, etc.? How should functional obsolescence be treated? What is the normal useful life of each asset and has the life been extended by a major rebuild? What is the remaining useful life? Is there a maximum level of depreciation for productive assets? Should a general, industry specific or asset class specific trend be used? What of economic / external obsolescence (a financial review may be required)? In this process the appraiser often will reclassify the assets into classes, for example, office furniture and equipment of the user may well become office furniture as one class and office equipment as another class. The data processing computer equipment of the user may become three or more classes, i.e., personal computers, servers and printers. This reclassification by the appraiser is necessary since indexing factors and depreciation factors should be applied to such assets appropriately by appraisal class, not accounting class. PRESENTING THE RESULTS Once completed, the appraiser may well present to the user a printed copy of the report in Excel, along with the narrative explanations of the valuation methodology. A personal presentation of the data is suggested, with discussions of each element of the valuation process being reviewed. Certain changes may be warranted, such as corrections of prior information supplied by the user, additional location or descriptive data, and more often discussions concerning the normal useful lives, remaining useful lives and maximum depreciation levels. Subsequent to discussions and corrections the final report is issued, with the data file being presented in an electronic format, as well as in a hard copy. WHAT ELSE IS THERE TO DO Depending on the requirements of the user there are additional services that may be considered, such as: Development of an ongoing control procedure for the system data, additions and deletions; An insurance appraisal, or insurance values; Property tax information (the prior system may be the basis of tax reporting renditions, or the new system may be the new data base, depending on the taxing jurisdiction); Preparation of an asset listing for financing or refinancing; Preparation for rollover of the business entity in 3 to 7 year (private equity, venture capital firms); Valuation of the real property; Cost segregation analysis of real property; and/or Valuation of specific classes of intangible assets. SUMMARY As shown, there is potentially more to an asset allocation for financial reporting than one may initially perceive. With the developing importance of Fair Value Accounting and the demands of Sarbanes-Oxley it is no longer a trivial matter.  But look at it positively, this work effort may result in a “fresh start” fixed asset system of a currently verifiable data file reflecting the assets that are employed by the business. In addition, there may well be ancillary benefits of the work effort over which the costs of implementation may be spread. Make the most out of it. Turn this difficult task into an accounting, financial reporting, operational and cost beneficial challenge and joy. In the long run you will be happy.
© Southeast Appraisal Resource Associates, Inc. 2015
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FINANCIAL REPORTING PURCHASE

PRICE ALLOCATION

Southeast Appraisal
Frankly speaking, we have seen too many fixed asset accounting systems, and as a generalization, they are mostly “bad”. From the largest to the smallest companies they are insufficient in how much data they can store and in what fields, how the data can be manipulated and used for management and reporting information purposes, and how they reflect the assets that are actually in use and in place. This is somewhat understandable. Fixed asset accounting is not a very exciting subject. Just think, how much did you really learn about the subject in an accounting, finance or MBA program? Also, often the employee with the lowest skill level in the accounting department is given the task of both entering the data and maintaining the system, without adequate training in procedures or information applications. This results in a flawed system from the onset, and/or loss of informational accuracy over time. But this is slowly changing. Due to the reporting and review requirements of SFAS 141/142/157 and Sarbanes-Oxley, companies are now taking fixed accounting somewhat more seriously (remember in a stock purchase before the old fixed asset data was simply moved over onto the acquirer’s books). Businesses are interested in having the data actually reflect what is out there, i.e., contributing to the revenue stream. Dreaming on, some day the base data may actually be the same as on the tax books of the company, and perhaps even be the same data used for property tax reporting (the latter may occur 20 years in the future). This article offers thoughts on the implementation of a fixed asset system resulting from a financial reporting purchase price allocation. It discusses the process from the first telephone call received, through the analysis and valuation process, to the data uploading and system maintenance. The information is somewhat general in nature since each company differs in their objectives and their ideas of how such a system should fulfill their specific accounting, operational and other informational needs. THE INITIAL ANALYSIS Usually the call to the appraiser goes like this, “Good Morning…..we just purchased XYZ Company and we need to have the assets appraised for financial reporting purposes.” An exploratory meeting is then scheduled. On the telephone, but optimally at a meeting, the appraiser should discuss the objectives and requirements of the engagement by asking at least the following questions: 1. Why do you want to have the assets appraised? 2. Are specific intangible assets also to be appraised? 3. Who is being asked to do the tangibles and/or the intangibles? 4. Will there likely be goodwill remaining after all the identifiable tangible and intangible assets are valued? Or is it a bargain purchase where there will be no goodwill, and in fact the tangible and intangible assets will be “squeezed down” to reflect economic obsolescence and/or negative goodwill. 5. How much confidence do you have that the current asset record reasonably reflects the assets that are in the facility? 6. Do you care about the structure and accuracy of the new fixed asset record? 7. What fixed asset software are you using? 8. What data fields are available and how many positions are in each field? 9. Can the current fixed asset file be downloaded / converted into an Excel file? 10. Please let me see the fixed asset system hard copy and the data file in Excel? 11. What do the codes mean? 12. What is captured in the cost of each asset, i.e., freight, labor, taxes, etc.? 13. What is the historic capitalization policy and what do you want it to be in the foreseeable future? 14. Were the values of the assets adjusted by a prior purchase price allocation?  If so, do you have the last data file prior to the allocation entries? 15. Does the system identify assets that were purchased new or used, or constructed “in house”? 16. How are the capital leased assets treated in the system, and are they identified? 17. What ancillary benefits do you wish to get out of this work effort, i.e., general asset control, insurance values, property tax info, asset control data, financing, future sale, etc.? 18. There may be more questions or issues that will surface during the completion of the allocation appraisal. THE DATA PROCESSING SYSTEM This article is not meant to be a review of the available systems, but there seem to be a number of minimum criteria for an adequate system. These are as follows: 1. PC based 2. Data section that contains the basic company and location identifiers 3. Asset descriptive section that contains the following: o Asset reference number, perhaps a tag or machine number o Photograph number, if available (this is a good idea) o Base asset descriptive information, 30 characters at least o Extended description, perhaps 252 characters or more o Manufacturer o Vendor / Distributor o Contact and telephone number of salesperson (wish item) o Model number o Serial number o Year originally manufactured o Year of major rebuilds o Asset suffix capability to link assets within a line or installation, yet control each asset by suffix individually o Optional data fields 4. Financial data section that contains the following: o Original cost (what the asset cost new when originally purchased, retain this always if available) o Historic cost (the cost as entered on the books) o Purchased new or used o Allocated cost, identified as such, perhaps by repetitive dates of acquisition in the record o Optional data fields specific to the user RESPONDING TO THE USERS NEEDS The requirements of users vary. At one end of the spectrum is the manager who accepts the data in the current system as reasonably accurate and wants to get through the valuation process as inexpensively and easily as possible.  On the other end is the manager who wants to truly control the assets, not only from an accounting perspective but also from a management information perspective. Either is right and appropriate, as well as all shades and variations in between. Based on the answers to the questions posed above, the valuer identifies the specific needs of the user. To assure the valuer has correctly “read” the user’s wishes a presentation should be made confirming the allocation valuation procedures, with the positives/negatives, and options stated. After discussion, a specific engagement letter should be written so there is not any misunderstanding of the scope, procedures and deliverables resulting from the assignment. WORKING WITH THE AVAILABLE DATA Suppose the base data is truly “bad”, listing a specific machine, as just “machine tool”. As such, there is no way to figure out by physically inspecting the plant what asset is identified on the fixed asset record. If the manager says to accept the asset record as appropriately reflecting the assets of the company, the appraiser can only “trend and bend” (see following section on this phrase) the asset values. Depending somewhat on the vintage of the assets, the trite saying “junk in, junk out” may apply in this case. But, the old asset record may reasonably reflect the costs, and the asset record although not being detailed, may reasonably reflect the right values. Yet suppose the user recognizes the shortcomings of the existing system and data, and wants a new factually based system that truly reflects the assets found in the facility. In this case the old fixed asset data is essentially thrown out and a new physical inventory of the assets is completed. Specific assets over the capitalization level of the user are individually scheduled and appraised, with assets under this threshold level being grouped as a category (thereby not missing any of the asset value). This process is perceived by some users as an opportunity to create an accurate new fixed asset data system, removing all the old and perhaps inaccurate information (a fresh start without there being any cost, how nice). Many users are in between, they want to “trend and bend” the minor assets but physically look for, verify and value individually the major assets (those of high dollar levels). It is this appraiser’s opinion that this is the minimum that should be done, thereby demonstrating reasonable thoroughness and accuracy for audit and third party review (think of Sarbanes- Oxley and SFAS 141 at this moment). “TREND AND BEND” Appraisers, particularly those that work / worked for the larger independent appraisal firms or major accounting firm’s appraisal departments, use the term “trend and bend.” Simply stated, the appraiser “trends” the original cost of an asset, using the date of original manufacture, by indexing this cost data for inflation to derive a current value. This amount is then depreciated from an appraiser’s perspective to reflect the current depreciated replacement cost new.  With an assumption of adequate economic support (considering intangible asset value) this amount may be equated to the Fair Market Value. This process is not as easy as it sounds. The appraiser should consider the following: Aforementioned statements of new or used, allocated, capital lease entry, etc. What is in the original cost data as noted above, freight, labor, engineering, design, etc.? How should functional obsolescence be treated? What is the normal useful life of each asset and has the life been extended by a major rebuild? What is the remaining useful life? Is there a maximum level of depreciation for productive assets? Should a general, industry specific or asset class specific trend be used? What of economic / external obsolescence (a financial review may be required)? In this process the appraiser often will reclassify the assets into classes, for example, office furniture and equipment of the user may well become office furniture as one class and office equipment as another class. The data processing computer equipment of the user may become three or more classes, i.e., personal computers, servers and printers. This reclassification by the appraiser is necessary since indexing factors and depreciation factors should be applied to such assets appropriately by appraisal class, not accounting class. PRESENTING THE RESULTS Once completed, the appraiser may well present to the user a printed copy of the report in Excel, along with the narrative explanations of the valuation methodology. A personal presentation of the data is suggested, with discussions of each element of the valuation process being reviewed. Certain changes may be warranted, such as corrections of prior information supplied by the user, additional location or descriptive data, and more often discussions concerning the normal useful lives, remaining useful lives and maximum depreciation levels. Subsequent to discussions and corrections the final report is issued, with the data file being presented in an electronic format, as well as in a hard copy. WHAT ELSE IS THERE TO DO Depending on the requirements of the user there are additional services that may be considered, such as: Development of an ongoing control procedure for the system data, additions and deletions; An insurance appraisal, or insurance values; Property tax information (the prior system may be the basis of tax reporting renditions, or the new system may be the new data base, depending on the taxing jurisdiction); Preparation of an asset listing for financing or refinancing; Preparation for rollover of the business entity in 3 to 7 year (private equity, venture capital firms); Valuation of the real property; Cost segregation analysis of real property; and/or Valuation of specific classes of intangible assets. SUMMARY As shown, there is potentially more to an asset allocation for financial reporting than one may initially perceive. With the developing importance of Fair Value Accounting and the demands of Sarbanes-Oxley it is no longer a trivial matter.  But look at it positively, this work effort may result in a “fresh start” fixed asset system of a currently verifiable data file reflecting the assets that are employed by the business. In addition, there may well be ancillary benefits of the work effort over which the costs of implementation may be spread. Make the most out of it. Turn this difficult task into an accounting, financial reporting, operational and cost beneficial challenge and joy. In the long run you will be happy.