Financial Analysis
EQUITY, BUSINESS ENTITIES, ESTATES, INTANGIBLES, AND ECONOMIC VALUE

Special Topics:

• International Services - Federal Tax Issues
• Interest Expense Attribution (864e)
• Intercompany Transfer Pricing (482)
• Due Diligence
• Valuing Intellectual Property
• Insolvency Valuations Under IRC (108b)
• Accounting for the Impairment of Long-Lived Assets (FASB 121)
• Accounting for Acquired "In Process" Research & Development Costs (FAS 2)

Are there unseen liabilities in your company's assets? The impact of rapidly changing economic, regulatory, and technological forces on asset value is a critical issue for business today. The potential economic effects have become even more acute with the implementation of FASB 121: Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.

FASB 121 asks this essential question:

Do the cumulative, undiscounted cash flows of a long-lived asset exceed its current book carrying value?

The key is to identify questionable assets before an audit. This affords your business the opportunity to plan rather than react. Otherwise, auditors may compel your firm to write down assets, representing a significant risk for a charge against earnings and damage to shareholder relations.

ARTHUR CONSULTING GROUP has unparelleled experience valuing businesses and their underlying assets. Our long-term success stems from applying a multidisciplined approach to the businesses and assets we value.

FASB 121 was created to provide authoritative guidance on recognizing and measuring the impairment of an asset. The standard applies to:

• Most long-lived assets, such as plant, property, and equipment,
• Certain identifiable intangibles,
• Goodwill related to those assets to be held and used, and
• Long-lived assets and certain identifiable intangible assets to be liquidated.

FASB 121 applies to fiscal years beginning after December 15, 1995, and affects all long-lived and certain intangible assets. For assets with significant lives, discounting may deprive a business of as much as 50 percent of the asset's cumulative cash flows. Take one example: Consider an asset that will generate $100 per year for the next 20 years. This asset passes the FASB 121 test if it's carried on the books at $2,000 or less. If it's carried at any higher value, it must be written down to $740, the total of 20 years of discounted cash flows (assuming a 12 percent discount rate).

Several major oil companies have already felt the sting of FASB 121 on company earnings and shareholder value. Other industries are beginning to feel its force. However, with forethought and planning, management can mitigate the effects while remaining in full compliance.

How to Recognize an Impairment for Assets held and Used

First, you must identify assets with a potential impairment in value. FASB 121 provides examples of "triggers" -- events or changes in circumstances pointing to the need for reviewing an asset. These examples include:

• A significant decrease in the market value of an asset. For instance, given the significantly lower price of crude oil since 1986, oil reserves acquired in past years may need to be revalued.
• A significant change in the extent or manner in which an asset is used, or a significant physical change in an asset.
• A significant change in the legislation or business climate that could affect the value of an asset. For example, after passage of the Clean Air Act Amendments of 1990, oil refineries saw their returns decline.
• Costs that significantly exceed the amount originally budgeted to acquire or construct an asset; for example, an electric power plant or other large facility with significant construction delays.

If these or other circumstances indicate that an asset's carrying amount may not be recoverable, the next step is to examine the asset's future net cash flows. If these undiscounted net cash flows are less than the carrying amount of the asset, an impairment loss should be recognized.

The amount of an impairment loss is measured as the excess of the asset's carrying amount over the fair value of the asset. The asset's carrying amount is its cost minus any accumulated depreciation or amortization. The asset's fair value is the amount at which the asset could be bought or sold under current market conditions.

Estimates based on valuation techniques include determining the present value of expected future cash flows using an appropriate discount rate. This can involve potentially complex analyses such as option pricing, and option-adjusted spread models.

FASB 121 identifies three methods for determining fair market value:

1. Quoted market prices in active markets.
2. Estimates based on prices of similar assets.
3. Estimates based on valuation techniques.

When you estimate fair market value on the basis of the present value of expected future cash flows, you must group the assets at the lowest level for which there are independent, identifiable cash flows. For example: A company has four long-lived assets. The value of one of these assets is impaired. If the cash flows of the four assets can be separately identified, only the stream associated with the impaired asset should be used to measure the value. If the cash flows of two of these are intermingled and can't be separated, their joint cash flows should be considered, even if the second asset is not impaired.

Once an impairment loss is recognized, the reduced carrying amount is its new cost basis. For a depreciable asset, the new cost basis controls its depreciation over the asset's remaining useful life. Once you recognize an impairment loss on an asset, the original basis cannot be restored.

FASB 121 ties accounting for assets to be disposed of to APB-30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. APB-30 specifies accounting for the disposal of a segment of a business, and requires that certain assets included in that type of transaction be measured at the lower of carrying amount or net realizable value.

Long-lived and intangible assets, subject to the requirements of FASB 121 that are not covered by APB-30, should be reported at the lower of carrying amount or fair value less cost to sell. Fair value is determined the same way as for assets to be held and used. Determining the cost to sell an asset to be disposed of may require significant judgment.

Revisions in estimates of fair value less cost to dispose are reported as adjustments to the carrying amount of the asset, subject to the limitation that the asset's carrying amount cannot exceed its carrying amount before adjustment was made to reflect the decision to dispose of the asset.

Why Choose Arthur Consulting Group?

ARTHUR CONSULTING GROUP is committed to professional excellence, consistently achieved through the application of qualified senior consultants to every assignment. Our staff includes economists, financial analysts, statisticians, industry analysts, CPAs, engineers, and other specialists whose multidisciplinary skills are required for these complex tasks. Our consultants have worked with top corporations, law firms, and the IRS to provide business valuations, to develop methodologies, and to support findings across a wide range of industries and applications.