| VALUATION RESEARCH CORPORATION | MARSHALL & STEVENs, INC. |
By
Alfred M. King, Chairman, Valuation Research Corporation
Mark Santarsario, President, Marshall & Stevens, Inc.
We appreciate the opportunity to make this presentation. Our firms are two of the largest independent valuation firms in the country. The valuation units of the major accounting firms are direct competitors.
Neither now, nor at any time in the past, have we believed that public accounting firms should be precluded from providing valuation services to non-audit clients. They have just as much right as anyone to compete for business. The valuation arms of accounting firms are good competitors, they provide excellent service at essentially competitive fee levels.
We do feel that for any accounting firm there is a basic incompatibility between developing value information for a client and then auditing that same information.
In a business combination accounted for as a Purchase, (and the current FASB proposals may require that all Business Combinations be accounted for as a Purchase), there is a lot of professional judgment required in separating out the Fair Value of tangible from intangible assets. Further, additional judgment is required in determining the appropriate lives to be assigned to each asset or class of asset. The impact of these valuation assumptions on a purchase price allocation directly affects the Balance Sheet, and current as well as future Income Statements. This information can and should be independently audited.
It is our observation when the same firm does the original work and conducts the subsequent audit, that there is often little or no independent review.
We have been in numerous competitive situations over the years in which we have lost a valuation assignment for allocation of a purchase price to a prospective client's auditor. Subsequently, upon asking the reason for the client's decision, we have been told that they chose to have their accounting firm perform the valuation assignment to allocate the purchase price because "we were told the audit would go easier if we had them do the work." Alternatively we have sometimes been told, "Well, your fee was lower but our accountants said they would match your fee and then we would save money because the auditor would not have to spend time reviewing the work. "
On the other side, we have also had numerous situations where our clients' independent public accountants carefully review our appraisal report. It is the audit firm's valuation professionals who typically perform this review. Knowing this review will take place, and knowing the type of questions they will ask, as well as the depth of their probe, keeps us 'on our toes' in performing our work. We end up doing better work, and the client as a Registrant, obtains better and more supportable valuation answers. There is no substitute for having the work of one professional reviewed by an independent professional.
In the United States, and the rest of the world for that matter, we are moving towards a Fair Value basis of financial accounting and reporting. Both for Balance Sheets and the determination of periodic income, the use of value information is becoming an increasingly important element. As examples of the U.S. GAAP requirements for valuation, look at such areas as Asset Impairment, IPR&D, Stock Options for compensation, Lease Residuals, Financial Instruments and many types of liabilities for which the exact amount may be a matter of valuation judgment.
The reason that it essentially requires a professional appraiser to review some other valuation is straightforward. Valuation principles are simple and easily understood. Determining which of many possible appraisal principles and methodologies is most appropriate in a particular situation is not so clear. Should we use as the Premise of Value the assumption that the assets will be sold, or do we look at replacement value assuming that the assets will continue in use? Do we accept management's forecast and assumptions uncritically or do we question them closely, sometimes requiring changes in such management forecasts? Do we utilize the Market Comparable approach to value or is it more appropriate to utilize the Cost Approach?
Answers to these fundamental questions are often not explicitly spelled out in the final report, and therefore a reader of the report may not realize what the truly key questions should be. Quite frankly, many auditors -- in terms of training and background -- do not have the experience or expertise to understand fully the implications of the choice of appraisal assumptions. An accounting firm's valuation professionals do have this expertise.
To sum up then, we believe that valuation information is becoming an ever more important part of financial reporting. Valuation requires judgment. The judgment calls of an appraiser should be reviewed by those with valuation background. If the same firm performs the valuation and then audits the numbers, it is highly likely that the so-called 'review' will be more for form than for substance. Self-review, per se, is not acceptable in this era when a single penny per share change in reported earning can swing the price of a stock 10% or even 20% or more. A change in valuation assumptions will often affect earnings by way more than a penny a share.
You have asked for comments on the Costs and Benefits of your proposals.
It is our considered opinion that, if your proposals are adopted, costs for Registrants may increase slightly. Our analysis is as follows:
Offsetting this, we believe that there will be significant benefits. Valuations will be better, inasmuch as they will be subjected to additional scrutiny. It is human nature if one knows that a peer is going to review one's work one will try just that much harder to avoid undue criticism. Additional oversight by a second firm will challenge the appropriateness and supportability of the key assumptions that go into every appraisal and valuation report.
As ever more financial information is affected by requirements for Fair Value, it will become increasingly important for valuations to be reviewed independently, even at slight additional cost.
Finally, we would like to comment briefly on the differences we perceive between your proposals and those of the Independence Standards Board ("ISB") when they took up the subject of auditor independence and valuation services.
The ISB proposal would have permitted valuations by accountants as long as the work was 'not material'. Under their approach there would be difficulty in interpreting what is and is not 'material'. On balance, we prefer your proposal if for no other reason than it will preclude potential arguments about what valuation work is or is not material.
Reading your proposals it is not clear to us where you come out on allowing auditors to perform valuation work for what the ISB referred to as "tax-related valuations as part of the planning or implementation of a tax-planning strategy, or to comply with tax requirements".
It is our recommendation that the Commission preclude accountants from performing purchase price allocation work for tax purposes. It is highly likely that the same information could be used in some way for financial reporting, either currently or in the future, for example when disposing of a business segment and determining gain or loss.
For all other 'tax-planning strategies', such as Section 482 [transfer pricing] or Section 861 [interest allocation] we believe that it would be cost-effective for registrants if you were to allow accounting firm tax professionals and valuation professionals to work together in what is often an iterative decision process.
We would be pleased to answer any questions.