Shannon Farr gave this presentation at the 2011 GA HFMA Fall Institute on Nov. 11, 2011 in Savannah, GA.

1. A Global Reach with a Local Perspective
www.decosimo.com
Fair Value for Healthcare Entities’ Financial
Reporting
Decosimo Advisory Services Georgia HFMA 2011 Fall Institute
Shannon Farr, CPA•ABV•CFF November 11, 2011

2. Shannon Farr
CPA•ABV•CFF
Valuation Manager | shannonfarr@decosimo.com
Shannon Farr is a valuation manager with more than 15 years
of accounting experience. Her practice has focused on
business valuation and litigation support since 2004. She is
accredited in business valuation (ABV) and also certified in
financial forensics (CFF).
Shannon provides valuation services to clients in a wide
variety of industries, with a focus on healthcare entities. Her
specialized expertise in this area assists hospital and health
system clients in ensuring their acquisitions meet industry
regulations surrounding the concepts of fair market value and
commercial reasonableness. Shannon also performs fair value
for financial reporting valuations to be used in purchase price
allocations and goodwill impairment testing.

3. Objectives
 Identify the various standards and standard-setting bodies
involved in fair value determinations for healthcare entities
 Understand the differences between fair value and fair market
value – and the circumstances in which each applies
 Discuss the variety of circumstances healthcare entities
encounter requiring a fair value or fair market value
determination
 Accounting for acquisitions – understand the purchase price
allocation process
 Identify specific intangible assets commonly found in
healthcare organizations and methods of valuing those assets
 Evaluate recent guidance on contingent consideration
 Understand the GAAP impairment requirements and order of
testing regarding long-lived assets; goodwill; and specifically-
identified, indefinite-lived intangible assets

4. Alphabet Soup: Valuation Credentials and
Authoritative Standards and Bodies
 AF  CBA
 USPAP  MCBA
 IRC  AVA
 ASA  AVC
 FASB  CM&AA
 CPA  AICPA
 ABV  NACVA
 CFA  SSVS
 ASC  CVA
 One of these is not a real organization, set of
 ASU standards, or credential – do you know which?

5. Fair Value for Financial Reporting Applications in
Healthcare
 Who?
All entities preparing GAAP financial statements
 What?
 Purchase price allocations (acquisitions): how much
did you pay? And, what did you get?
 Goodwill impairment: Is it still worth it?
 Stock-based compensation: what are these shares
I’m issuing to employees and executives worth?

6. What is Fair Value?
 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.

7. Healthcare Fair Market Value
 IRS definition (applies to transactions and
agreements of nonprofit entities)
the price, expressed in terms of cash equivalents, at
which property would change hands between a
hypothetical willing and able buyer and a hypothetical
willing and able seller, acting at arm’s length in an
open and unrestricted market, when neither is under
compulsion to buy or sell and when both have
reasonable knowledge of the relevant facts.

8. “Healthcare” Fair Market Value (FMV)
 The fair market value standard typically applies in a healthcare
transaction. Stark Regulation 420 CFR 411.351 defines FMV as follows:
…the value in arms-length transactions consistent with the general market
value. ‘General market value’ means the price that an asset would bring as
the result of bona fide bargaining between well-informed buyers and
sellers who are not otherwise in a position to generate business for the
other party; or the compensation that would be included in a service
agreement as a result of bona fide bargaining between well-informed
parties to the agreement who are not otherwise in a position to generate
business for the other party, on the date of acquisition of the asset or at
the time of the service agreement. Usually, the fair market price is the price
at which bona fide sales have been consummated for assets of like type,
quality, and quantity in a particular market at the time of acquisition, or the
compensation that has been included in bona fide service agreements with
comparable terms at the time of the agreement, where the price or
compensation has not been determined in any manner that takes into
account volume or value of anticipated or actual referrals. With respect to
rentals and leases described in §411.357(a), (b), and (l), “fair market value”
means the value of rental property for general commercial purposes (not
taking into account its intended use).

9. One of these things is not like the other…
Healthcare Fair Market Value (regulatory compliance):
Acquisitions of healthcare entities,
Physician-employment agreements,
Physician on-call and coverage arrangements,
RVU-based compensation arrangements,
Medical director service agreements,
Management services contracts between physicians
and hospitals,
Clinical co-management arrangements, and
Joint ventures and “under arrangements.”

10. Or are they?
 The Stark Law “general market” concept is very
similar to the FASB’s “market participant” concept
 So what does that mean?
 Fair value and “healthcare fair market value” are both
determined without regard to a specific buyer’s
synergies

11. Fair Value GAAP
 FASB Accounting Standards Codification (ASC) Topic
820, Fair Value Measurements and Disclosures
 Goodwill impairment – ASC Topic 350, Intangibles –
Goodwill and Other (formerly SFAS No. 142)
 Purchase price allocation – ASC 805, Business
Combinations (formerly SFAS No. 141R)
 Stock issued as compensation – ASC 718, Compensation
– Stock Compensation
Note: While originally excluded from the requirements of
SFAS Nos. 141 and 142, ASC 958 (formerly SFAS No. 164)
extends the business combination and annual goodwill
impairment testing requirements to not-for-profit entities
for fiscal years beginning after December 15, 2009.

12. Market Participants
Physician medical groups – after 10 or so years,
hospitals and integrated delivery systems have been
returning as buyers of physician practices:
Physician Medical Group
Announced Mergers and
Acquisitions
Year Total Deals Hospital Deals
2008 52 15
2009 41 12
2010 63 23
Source: Irving Levin Associates, Inc., The Health Care Services Acquisition Report, Seventeenth Edition, 2011)

13. Market Participants, continued
 Home health care – of 43 announced deals during
2010:
 12 publicly-traded corporations announced 26 deals
 10 privately-held and 7 nonprofit organizations announced 1
deal apiece: these organizations were hospitals, senior care
companies, and one private equity group.
 Laboratory, imaging, and dialysis – of 41 2010
announced deals:
 11 publicly-traded corporations announced 24 deals
 11 privately-held and 4 nonprofit organizations announced 1
deal apiece (1 privately-held company made 2 acquisitions)
 21 imaging deals comprised 51% of the total followed by
laboratory services (14 deals/34%) and dialysis (6 deals/
15%)

14. PURCHASE PRICE
ALLOCATION

15. Purchase Price Allocation
 Purpose
 Timing
 GAAP guidance

16. What is the Purchase Price?
 Now includes not only cash and value of equity
issued to the seller at closing, but also the fair value
of any “contingent consideration”

17. Contingent Consideration
 What is “contingent consideration”?
 An obligation of the acquirer to transfer additional assets or
equity interest to the selling shareowners of a target if
specified future events occur or conditions are met
 Commonly referred to as “earn outs”
 SFAS 141R (ASC 805) – recognize fair value at
acquisition, remeasure as new information becomes
available
 Remeasurement is required at every balance sheet date
 How is fair value at acquisition determined?
 Probability distribution of the outcomes
 Option pricing methods

18. Contingent Consideration
 For acquisitions completed prior to 2009:
 Payments of contingent consideration (earnouts) are
recorded typically as an increase to goodwill when
paid (or conditions are met)
 For recent acquisitions (new guidance)
 The fair value of the earnout provisions must be
determined as of the closing date and recorded with
the acquisition

19. Contingent Consideration
 In theory, the amount that would be paid to a market
participant to assume the contingent consideration
liability must be determined.
 In practice, a valuation model must be tailored to
each contingent consideration agreement
considering the specified:
 performance metrics,
 measurement periods,
 performance hurdles, and
 payment terms.

20. A Real-life Example
 The following disclosure is made by MedNax (formerly
Pediatrix) in Note 6, Business Acquisitions, to its 2010 financial
statements, as part of its discussion of its 2010 acquisitions of
15 physician group practices:
“The contingent consideration of $10.6 million recorded during
2010 is related to agreements to pay additional amounts based
on the achievement of certain performance measures for up to
five years ending after the acquisition dates. The accrued
contingent consideration for each acquisition was recorded at
acquisition-date fair value using the income approach with
assumed discount rates ranging from 3.0% to 6.0% over the
applicable terms and an assumed payment probability of 100%
for each of the applicable years. The range of the undiscounted
amount the Company could pay under the contingent
consideration agreements is between $0 and $12.1 million.”

21. PPA: What Did you Buy?
 Working capital assets, net of liabilities
 Potential issues in determining the fair value of
accounts receivable, if acquired
 Fixed assets
 Need a fixed asset appraisal of significant land,
buildings, and equipment acquired
 Identifiable Intangible Assets
 Goodwill

22. What is an Identifiable Intangible Asset?
 It is capable of being separated from the entity and
sold, transferred, licensed, rented or exchanged,
either individually or with a related contract,
identifiable asset, or liability (regardless of whether
there is intent to do so)
 OR
 It arises from contractual or other legal rights

23. Identifiable Intangibles Common in Healthcare
 Marketing-related: trademarks or tradenames, internet
domain names
 Patient-related: patient lists or files, referral relationships
 Contract-based: non-compete agreements, payor
contracts, employment contracts, certificates of need,
provider numbers, Joint Commission accreditation,
management agreements, lease agreements
 Technology-based: proprietary technology, patents or
formulas
 Workforce-in-place is always considered part of goodwill

24. Approaches to Measuring the Fair Value of
Identified Intangible Assets
 The Cost Approach
 Based on the economic principle of substitution: the value
of the intangible asset is the estimated cost to either
purchase or construct an asset of equal utility
 The Market Approach
 The value of the intangible asset is estimated by identifying
and analyzing the price at which similar assets have been
exchanged between willing buyers and sellers
 The Income Approach
 The value of the intangible asset is equal to the present
value of the expected income to be earned form the
ownership of the asset

25. Approaches and Techniques to Measuring
the Fair Value of Identified Intangible Assets
 The Cost Approach
 Replacement cost method
 Reproduction cost method
 The Market Approach
 Relief from royalty method
 Comparable transactions method
 The Income Approach
 The profit split method (25% Rule)
 The excess earnings method
 Loss of income (scenario) method
 Multi-period excess earnings method

26. Assembled Workforce
 Although the value of the acquired entity’s assembled
workforce is always recorded as part of goodwill, it is
useful to estimate the value of the assembled workforce
and consider that value in relation to the concluded value
of goodwill (in other words, the total assigned to goodwill
should be at least equal to the value of the assembled
workforce).
 The value includes factors such as: the cost to recruit,
hire and train new employees of comparable experience
and expertise
 The value is typically estimated as a percent of total
compensation for various classifications of employees
(i.e. the % of compensation used in the cost estimate
related to employee-physicians and registered nurses will
be higher than that used for receptionists and clerical
personnel).

27. The Income Approach: Discounted Cash
Flows
 Typically used for the primary (i.e. the perceived most
important specifically-identified intangible asset acquired
in the deal).
 Involves estimating an income or cash flow stream and
an appropriate discount rate reflecting the risk of the
cash lows
 The most important consideration:
The measure of economic income (cash flows) used in
the valuation of an intangible asset must relate only to
income generated by the subject intangible asset
 Which begs the question: how are cash flows from a
specific intangible asset isolated?
 The answer: contributory asset charges

28. Contributory Asset Charges
 The measure of economic income used in the valuation of
an intangible asset must relate only to income generated
by the subject intangible asset.
 For example, the primary specifically-identified intangible
asset in many deals is a certificate of need. However vital
to the success of the acquired entity, a certificate of need
must be accompanied by other assets, such as working
capital, necessary equipment, and a trained and
assembled workforce.
 To determine the value of the primary intangible asset,
first determine the value of the other intangibles, then
compute contributory asset changes to isolate cash flows
from the primary asset.

29. Noncompete Agreement Valuation Example
 Noncompete agreements restricting the former
owners of an entity from competing within the local
market are commonly seen in healthcare
transactions
 Certain legal restrictions may inhibit enforceability
 The value of a noncompete agreement can be
determined based on two factors:
1. The likelihood that the former owner(s) would
compete in the absence of the agreement, and
2. The percentage or dollar amount of future
revenues that would be lost to that competition.

30. Noncompete Agreement: Simplified
Example Step 1

31. Noncompete Agreement: Simplified
Example Step 2

32. Common Sense Always Applies
 All else being equal, a certificate of need acquired
through an acquisition in a state or market
designated as sufficiently covered (i.e. new
certificates of need for that service are not
anticipated in the future) will be more valuable than a
certificate of need acquired in an area allowing new
entrants to compete in the market.
 FACTS and CIRCUMSTANCES must be considered

33. Other Purchase Price Allocation Issues
 Calculating the tax amortization benefit associated with
each identified intangible asset
 The excess of purchase price over the values assigned to
all identified assets and liabilities is goodwill
 Estimating the useful lives of identified intangible assets
 Comparing the Weighted Average Return on Assets
(WARA) to the Weighted Average Cost of Capital (WACC)
 Goodwill and identified intangible assets with indefinite
lives must be evaluated annually for impairment

34. GOODWILL IMPAIRMENT

35. Goodwill Impairment Testing Basics
 Goodwill is tested for impairment at least annually
using the two-step test prescribed in ASC 350
 However, a recent Accounting Standards Update
(ASU) allows a “Step Zero” qualitative assessment

36. The Step-Zero Impairment Assessment
 Qualitative factors for management to consider prior to the
performance of the two-step impairment test include the
following:
 Macroeconomic conditions: a deterioration in general economic
conditions, limitations on accessing capital, fluctuations in
foreign exchange rates;
 Industry conditions: a deterioration in the market in which an
entity operates, increased competition, a decline in market-
dependent multiples or metrics, or a regulatory or political
development;
 Cost factors: increases in raw materials, labor, or other
significant costs;
 Overall financial performance: negative or declining cash flows;
 Entity-specific events: changes in management or key
personnel, changes in strategy, contemplation of bankruptcy,
litigation issues, etc.

37. The Step Zero Assessment
 If qualitative assessment indicates that “it is more
likely than not” that the fair value of a reporting unit
is less than its carrying amount,
the entity is required to proceed to Step 1 of the
goodwill impairment test

38. The Two-Step Goodwill Impairment Test (ASC
350)
 Step 1 – identify potential impairment by comparing
the fair value of a reporting unit to the carrying value
of that reporting unit
 New guidance on evaluating reporting units with
negative carrying amounts (e.g., debt has been
assigned to the RU): an entity cannot assume
goodwill is not impaired
 Step 2 – if goodwill is potentially impaired, recognize
and measure the amount of the impairment loss

39. Reporting Unit (RU) Identification
 A reporting unit is defined as an operating segment
or one level below (also known as a component)
 A component of an operating segment would be
considered a reporting unit if it is 1) a business, 2)
has discrete financial information, and 3) segment
management routinely reviews that financial
information
 Components that share similar economic
characteristics are aggregated

40. Reporting Unit Assets and Liabilities
 Assets and liabilities must be thoughtfully assigned
to one or more (in the case of shared assets)
reporting units considering both of the following
criteria:
 The asset will be employed in,
or the liability relates to
The operations of the RU
AND
 The asset or liability will be considered in determining
the fair value of the reporting unit

41. What Does that Mean?
 If debt or other liabilities are assigned to the RU,
decreasing the carrying value (and the potential for
impairment)
THEN
the settlement of that debt or other liabilities must be
reflected as a reduction of cash flows in determining
the fair value of the reporting unit

42. Common Techniques used to Measure the Fair
Value of the RU
 Discounted cash flow (DCF) method
 Guideline public company method
 Guideline transaction method

43. DCF Key Inputs
 Prospective financial information (PFI)
 Discrete period cash flow (often 3 to 5 years)
 Terminal cash flows
 Discount rate
 Long-term growth rate

44. Prospective Financial Information
 Incorporate Recent Developments
 Future infrastructure requirements
 Healthcare reform effects on revenue
 “New era” impacts on profitability

45. Discount Rate
 Associated with risks facing the RU
 Determined with consideration to qualitative factors
similar to those outlined by the ASU allowing the
Step Zero assessment

46. Long-term Growth Rate
 Represents the long-term growth of net cash flow
 Must consider the positive effects of increased
demand due to the aging population offset by
pressure on profits due to decreasing
reimbursement rates
 Very unlikely to exceed long-term anticipated growth
of GDP as a whole (around 2.5% - 3%)

47. Guideline Transaction Method
 Uses information from acquisitions of comparable
companies
 Generally considered of limited use in healthcare
valuations because of the relatively extreme
differences in local and/or state markets in which
healthcare entities operate

48. Guideline Public Company Method
 The GPC uses information on multiples of similar
publically-traded companies to derive a value for the
reporting unit
 Especially useful for hospitals, home health care,
and ambulatory surgery centers

49. Current Industry Multiples

50. Applying GPC Multiples
 Determine which multiples are the most relevant
 Evaluate whether adjustments to the GPC financial
metrics are necessary
 Apply selected multiples to the RU financial metrics
 Evaluate results
 Consider whether a control premium is necessary

51. Form the Step 1 Conclusion
 What fair values are indicated by the various
techniques employed? (Note: GAAP requires the
application of all applicable methods)
 How does the determined fair value of the RU
compare to its carrying value?
 If the fair value exceeds the carrying value, there is no
need to proceed to Step 2
 If the carrying value of the RU exceeds the indicated
fair value, proceed to Step 2

52. Step 2
 The assets and liabilities (existence and value)
booked in the past are useful but not determinative
 Unrecorded assets and liabilities of the RU may exist
 The value of identified intangible assets may have
changed
 Deferred tax impacts need to be considered

53. Step 2, continued
 The FV of the reporting unit less the FV (not the book
value) of all RU assets and liabilities at the valuation
date = the implied value of goodwill
 Is the implied value of goodwill greater than or less
than the RU’s recorded goodwill?
 If less than, the difference between = an impairment
loss

54. Alphabet Soup: Valuation Credentials and
Authoritative Standards and Bodies
 AF – the Appraisal Foundation  AVA – Accredited Valuation Analyst
 USPAP – Uniform Standards of Professional  AVC– If you chose this one, you were right!
Appraisal Practice
 CM&AA – Certified Merger and Acquisition
 ASA – Accredited Senior Appraiser of the Advisor
American Society of Appraisers
 HFMA – Healthcare Financial Management
 IRC – Internal Revenue Code (Rev. Ruling 59-60) Association
 FASB – Financial Accounting Standards Board  AICPA – American Institute of Certified Public
Accountants
 CPA – Certified Public Accountant  ABA – American Bar Association
 ABV – Accredited in Business Valuation  AHLA – American Health Lawyers’ Association
 CFA – Chartered Financial Analyst  NACVA – National Association of Certified
 ASC – Accounting Standards Codification Valuation Analysts
 ASU – Accounting Standards Update  SSVS – Statement on Standards for Valuation
Services
 CBA – Certified Business Appraiser  CVA – Certified Valuation Analyst
 MCBA – Master Certified Business Appraiser

55. Questions?

56. THANK YOU!