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Valuation Insights is a quarterly e-newsletter that provides you with the latest news from Duff & Phelps and the trends and changes in valuation and accounting that could affect your business transactions in Asia.
Our top stories include the latest 2016 U.S. Goodwill Impairment Study, which analyses the general industry trends of goodwill impairment; and a look at the valuation of IP for tax restructuring purposes.
We will also look at various important updates, including the new regulatory changes released by PRC for foreign investment in China; the impending CEIV credential for valuation professionals; and a strategic analysis of property, plant and equipment fair valuation under Indian Accounting Standard 16.
A recent study on goodwill impairment in the U.S. found that it has climbed to the highest levels since the 2008 financial crisis. U.S. companies recorded $57 billion of goodwill impairment in 2015 – these record impairment levels occurred despite a robust year for M&A activity in 2015, which resulted in $458 billion of goodwill being added to U.S. companies’ balance sheets.
“The potential for a goodwill impairment always exists…but especially in bad times,” explains Ricky Lee, Managing Director in Duff & Phelps' Valuation Advisory Services group overseeing financial valuation in Hong Kong. “I think the slowdown in the overall global economy, particularly in China where there's an oversupply of capacity, will have an impact on goodwill impairment testing.”
The 2016 U.S. Goodwill Impairment Study, prepared by Duff & Phelps in partnership with the Financial Executives Research Foundation, analyzed general and industry-specific trends for goodwill impairment for over 8,500 U.S. publicly-traded companies.
The report also includes the results of the annual goodwill impairment survey of Financial Executives International (FEI) members representing both privately-owned and publicly-traded companies.
The 2016 Survey found that 59 percent of respondents opted to use the Step 0 test, the highest number since the option was first made available. Subsequently, on 26 January 2017 the FASB has announced1 the removal of Step 2 to simplify the goodwill impairment test and by computing any goodwill impairment based on the difference between the fair value and the carrying amount of the reporting unit.
“In accounting standards, no matter if it's in the U.S. or in China, goodwill has to be tested for impairment every year. In the U.S. – 'Step 0' just simplifies the process,” explains Mr. Lee. “What Step 0 means is that companies do not need to do quantitative analysis, but instead, management can perform a qualitative assessment to determine if there is a need to perform the quantitative Step 1 test.”
1Accounting Standards Update No: 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment.
Read the 2016 U.S. Goodwill Impairment Study
Intellectual Property (IP) valuation makes up a significant portion of Duff & Phelps' work. Much of this work concentrates on providing a fair valuation for intangible assets like IP.
“You may think about how to maintain or structure IP from a tax perspective,” explains Ricky Lee, Managing Director for Duff & Phelps' financial reporting valuation practices in Hong Kong. “Let's say a patent is in some other country from where the founder is located, such as a high tax location like the UK or Germany. You may consider restructuring the IP ownership, by transferring it from a high tax jurisdiction to a country like Singapore or Hong Kong with lower taxes.”
Valuing IP in China mostly consists of designs, copyrights and brands. “We don't see major issues on how to value it,” says Lee. “For more technology-based IP, there will be more complications performing the valuation, for example in terms of research and development.”
A new article prepared by Duff & Phelps' Glen Kernick and Justin Kloos provides a framework to help evaluate whether to acquire or build IP, with key considerations for formulating assumptions and identifying challenges that decision-makers often encounter in the course of coming to a decision.
At the earliest stage, the article suggests making a determination if both paths are feasible. Certain factors may rule out one or the other: if either are equally viable, the path forward may ultimately boil down to a strategic investment decision influenced by other factors.
If the decision favors the “buy” direction, specific considerations – such as deal costs, integration costs and transaction-related risks (among others) need to be worked out before a decision is made. If a “build” scenario is likely, decision-makers should consider direct and indirect costs of creating the IP, its rate of market penetration, and certain specific risks once completed.
Read full Valuation Insights, Fourth Quarter 2016: Special Intellectual Property Edition here
2016 was a banner year for Chinese outbound mergers and acquisitions (M&A). From January to June, China's outbound M&A volume hit $135.3 billion surpassing the full-year total for any previous year recorded (source). For the first half of the year, Chinese companies made up 23 percent of all global cross-border deals (source).
This underscores the essential role played by independent valuation firms like Duff & Phelps in the China M&A market.
“We help foreign offshoots of the Chinese state-owned companies or private companies, when they do deals, to comply with international accounting and international financial reporting standards,” explains Patrick Wu, Managing Director and Regional Leader of Duff & Phelps' Valuation Advisory Services practice for Greater China. “As a firm, we are very well positioned to do this work because of our global scale – we have teams that are familiar with the local conditions, local regulations, and we are recognized by global regulatory bodies around the world.”
Foreign companies in China also appreciate Duff & Phelps' help as they navigate the somewhat unpredictable business environment within China. Case in point: last September, the People's Republic of China published a new law amending the four laws governing foreign invested enterprises ("FIEs") including joint ventures ("JVs") and wholly foreign owned enterprises ("WFOEs").
Pursuant to the Provisional Administrative Rules on Foreign-Invested Enterprises’ Establishment and Amendment published on October 2016 by China’s Ministry of Commerce (MOFCOM), new FIEs no longer need to be approved by MOFCOM, as long as the proposed businesses do not appear on a “negative list” provided by the government.
Foreign enterprises may see the revised regulations as part of a silver lining in China's reputation for constrictive regulations. “Foreign multinational companies operating in China have the complaint that they're now subject to a pretty stringent policy and regulatory environment,” says Mr. Wu.
“On the one hand, if you look at this catalog simplification and some financial market developments in Hong Kong, there's some positive news,” explains Mr. Wu. “On the other hand, a lot of foreign companies are facing a more hostile environment when doing business in China. There are some conflicting views.”
The worldwide business valuation profession has not had a globally-recognized professional credential. An initiative begun by the U.S. business valuation community may soon solve that issue: the new Certified in Entity & Intangible Valuations (CEIV) credential will soon be a prerequisite for business valuation professionals performing financial reporting fair value measurements for entities required to submit registration statements or filings to the SEC as well as private companies that prepare and issue financial statements in accordance with U.S. GAAP. In addition, any business engagement whereby the business valuation professional is performing valuation services will be required to comply with the Mandatory Performance Framework for the CEIV credential.
Mr. Patrick Wu, Managing Director and Regional Leader of Duff & Phelps' Valuation Advisory Services practice for Greater China, believes the CEIV credential (once implemented) in time is likely to also become mandatory for valuation professionals in Asia as well as the West, as “a standard credential for people who value business enterprises and intangible assets for financial reporting purposes.”
The addition of a uniform credential for business valuation professionals will be a positive development for the financial and investing community. Business valuation professionals conducting fair value measurement estimates will be able to subscribe to a consistent set of standards, with additional required training and examined expertise for their work.
We anticipate that public auditors will advocate positively and take steps to address the issue: the new Certified in Entity & Intangible Valuations (CEIV) credential will soon be a prerequisite for professionals performing Fair Value measurements for businesses and intangible assets.
We asked Patrick Wu, Managing Director and Regional Leader in Duff & Phelps' Valuation Advisory Services practice for Greater China, to explain the implications of the impending credential for the business community.
Why was CEIV conceived in the first place?
CEIV was initiated by the U.S. business valuation community to develop a uniform set of professional standards for the valuation industry. Three Valuation Professional Organizations (VPOs) were involved, the American Institute of Certified Public Accountants (AICPA), the American Society of Appraisers (ASA), and the Royal Institution of Chartered Surveyors (RICS). Through the CEIV, they've come up with a standard credential for people who value business enterprises and intangible assets for financial reporting purposes.
What does a professional need to achieve CEIV certification?
First of all, you need to be a member of one of the three VPOs I mentioned, and have a certain number of hours of fair value experience. You also need to take up a mandatory training course, as well as comply with a performance framework which governs the ongoing quality control, including inspection by these valuation professional organizations.
What are CEIV's effects on corporations, if any? Will they be aware of the certification, and how will it impact them overall?
Once the credential has been rolled out, it will be easier for the accounting firm and corporations to select accredited valuers. At the same time, the quality of valuation will be more consistent among firms that are conducting them.
What's the timetable for CEIV's implementation?
The VPOs will try to roll out the accreditation sometime this year.
It is unclear what the impact will be in Asia. In Hong Kong, we haven't yet seen the Securities and Futures Commission (SFC) of Hong Kong mention this aspect, although RICS may work with the Hong Kong Institute of Surveyors on the matter. It is not clear if the Hong Kong securities regulators or the Hong Kong Exchange and Clearing Limited (HKEX) are going to mandate an Asian initiative or join in the U.S. effort.
China is a bit different, as it is a separate system. We have the China Appraisal Society as a regulator, but Chinese appraisals also follow the standards of the International Valuation Standards Council (IVSC). Whether they will mandate compliance remains to be seen.
What is Duff & Phelps' response to CEIV?
We have a professional development committee responsible for this project. In fact, we have three members who sit on the U.S. based Fair Value Quality Initiative Committee who are very much involved with the entire accreditation process.
We are now starting to require all business valuation colleagues, at the manager level and above, to be members of one of the three VPOs I mentioned. We are watching very carefully to see when this credential will be rolled out. This is a U.S.-led effort, so first of all we will ensure that colleagues around the world who will be impacted by the accreditation’s become CEIV compliant.
First Time Adoption (FTA) of Indian Accounting Standards (Ind AS) raises several questions.
For Ind AS-compliant companies, uncertainty remains around how book profit is calculated for the purposes of levy of Minimum Alternate Tax (MAT) under section 115JB of the Income-tax Act 1961. In response, the Central Board of Direct Taxes in association with the Ind AS Committee issued a clarification dated July 23, 2016 recommending treatment for MAT regarding Ind AS 16 and Ind AS 38.
Prior to July 23, 2016, some companies were undecided whether to measure an item of property, plant and equipment (PPE) using recomputed value, deemed cost or carrying value. The election of valuation method raised concern regarding taxation of unrealized gains/losses under MAT.
The analysis presented here aims to dispel some of the remaining uncertainty surrounding the fair valuation of PPE in the context of the July 2016 clarification.
The analysis presents a framework that contextualizes the two permitted accounting models under Ind AS 16 (the Cost Model and the Revaluation Model), and in the instance of the latter, factors for consideration when measuring PPE at its fair value and using that fair value as its deemed cost.
Read the full Analysis on IAS 16
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