02-APB VFR Valuation Advisory 2 Valuation of Customer ...

1 JUNE 2016 APPRAISAL PRACTICES BOARD VFR Valuation Advisory 2: THE Valuation OF Customer -RELATED ASSETS COPYRIGHT 2016 BY THE APPRAISAL FOUNDATION. ALL RIGHTS RESERVED. APB VFR Valuation Advisory #2: The Valuation of Customer -Related Assets This communication is for the purpose of issuing voluntary guidance on recognized Valuation methods and techniques. Date Issued: June 15, 2016 Application: Business Valuation , Intangible Assets Background: Since the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157 (FASB Statement No. 157), predecessor to Accounting Standards Codification (ASC) 820 fair value Measurement (ASC 820), and FASB Statement No. 141(R), predecessor to ASC 805 Business Combinations, there has been increased interest in the identification and recognition of the fair value of assets and liabilities in financial statements.

2 Furthermore, the FASB and the International Accounting Standards Board (IASB) have been working on a convergence project with an objective of having a consistent set of accounting standards that can be used globally. In that regard, the IASB has issued International Financial Reporting Standards (IFRS) 3 (revised) Business Combinations (IFRS 3R), and IFRS 13 fair value Measurement, both of which are largely similar to the same statements issued by the FASB. Accordingly, during the creation of this document, members of the International Valuation Standards Council (IVSC) reviewed the document and discussed certain topics with members of this Working Group to try and ensure consistency with both a) Valuation concepts in the International Valuation Standards (IVS) and b) fair value guidance in IFRS 13 that existed at the date of publication of this document.

3 Because of the need for financial statements to be both reliable and relevant, Valuation practices must provide reasonably consistent and supportable fair value conclusions. To this end, it is believed that guidance regarding best practices surrounding certain specific Valuation topics would be helpful. The topics are selected based on those in which the greatest diversity of practice has been observed. To date, three Working Groups have been sponsored by The Appraisal Foundation. The first Working Group addressed the topic of contributory assets and charges in a document titled The Identification of Contributory Assets and Calculation of Economic Rents dated May 31, 2010 (now known as VFR Valuation Advisory #1 ).

4 The second Working Group has addressed the general topic of Customer -related assets in this document. A third Working Group is addressing the topic of the control premiums as applied in valuations done for financial reporting purposes. A fourth Working Group is addressing contingent considerations. This document is intended to present helpful guidance for those who are preparing fair value measurements of Customer -related assets; however, this paper is not intended to be an authoritative Valuation standard. The Working Group believes that consideration of the facts and circumstances related to the asset(s) that are being valued may support a departure from the recommendations of this document. APB VFR Valuation Advisory #2 - The Valuation of Customer -Related Assets 2016 The Appraisal Foundation 2 It is the belief of the Working Group that the Valuation of assets in general and Customer -related assets specifically is a complicated exercise that requires significant judgment.

5 This paper seeks to present views on how to approach and apply the Valuation process appropriate for Customer -related assets. The Appraisal Practices Board and The Appraisal Foundation wish to express our utmost gratitude to the Working Group on Customer -Related Assets for volunteering their time and expertise in contributing to this document. Specifically, sincere thanks to the following individuals: Working Group on Customer -Related Assets Dan Knappenberger, Chair Deloitte Transactions and Business Analytics LLP San Jose, CA Christopher Armstrong KPMG LLP Los Angeles, CA PJ Patel Valuation Research Corporation Princeton, NJPeter Wollmeringer Huron Consulting Group New York, NY Justin Kloos, Technical Writer Duff & Phelps, LLC Atlanta, GA Carla Glass, Steering Committee Oversight & Facilitator Meyers, Harrison and Pia, LLC New Haven, CT Subject Matter Expert Group on Best Practices for Valuations in Financial Reporting Jay E.

6 Fishman, Co-Chair - Financial Research Associates Carla G. Glass, Co-Chair - Meyers, Harrison and Pia, LLC Anthony Aaron - Ernst & Young LLP Paul Barnes - Duff & Phelps, LLC John Glynn - PricewaterhouseCoopers LLP Lee Hackett - Retired Matt Pinson - PricewaterhouseCoopers LLP Contributors & Special Thanks Aaron Gilcreast, PricewaterhouseCoopers LLP Ed Hamilton, Valuation Research Corporation Greg Forsythe, Deloitte Financial Advisory Services LLP, IVSC Liaison Alok Mahajan, KPMG, LLP, APB Liaison Adriana Berrocal, Building value Consulting, SC, APB Liaison Appraisal Practices Board Members (July 2015 June 2016) Rick O. Baumgardner, Chair Shawn Wilson, Vice Chair Adriana Berrocal Lisa Desmarais Ernest Durbin Jay E. Fishman Guy Griscom Donna VanderVries APB VFR Valuation Advisory #2 - The Valuation of Customer -Related Assets 2016 The Appraisal Foundation 3 The Appraisal Foundation Staff David Bunton, President John S.

7 Brenan, Director of Appraisal Issues Paula Douglas Seidel, Executive Administrator Staci Steward, Appraisal Practices Board Administrator The views set forth in this exposure draft are the collective views of the members of this Working Group and do not necessarily reflect the views of any of the firms that the Working Group members are associated with. The Appraisal Foundation served as a sponsor and facilitator of this Working Group. The Foundation is a non-profit educational organization dedicated to the advancement of professional Valuation and was established in 1987 by the appraisal profession in the United States. The Appraisal Foundation is not an individual membership organization, but rather an organization that is made up of other organizations.

8 Today, over 110 non-profit organizations, corporations and government agencies are affiliated with The Appraisal Foundation. The Appraisal Foundation is authorized by the US Congress as the source of appraisal standards and qualifications. APB VFR Valuation Advisory #2 - The Valuation of Customer -Related Assets 2016 The Appraisal Foundation 4 Table of Contents INTRODUCTION .. 6 ACCOUNTING BACKGROUND AND OVERVIEW .. 8 Accounting Standards and the Accounting Standards Codification .. 8 Business Combinations.

9 9 Asset Acquisitions .. 10 Goodwill and Indefinite-Lived Asset Impairment Testing .. 10 Long-Lived Asset Impairment Testing .. 11 IDENTIFICATION OF Customer -RELATED ASSETS AND value 14 Introduction .. 14 Identification of Customer -Related Assets .. 14 value Considerations .. 17 Valuation METHODOLOGIES .. 21 Introduction .. 21 Income Approach .. 21 Cost Approach .. 22 Market Approach .. 22 APPLICATION OF THE INCOME APPROACH .. 24 Introduction .. 24 Multi-Period Excess Earnings Method (MPEEM) .. 24 Distributor Method .. 39 With-and-Without Method .. 42 Cost Savings Method .. 47 APPLICATION OF THE COST APPROACH .. 49 Introduction .. 49 Cost Approach .. 50 APPLICATION OF THE MARKET APPROACH .. 54 Introduction .. 54 Methodology .. 54 Valuation METHODOLOGY 55 OTHER CONSIDERATIONS.

10 58 Introduction .. 58 Backlog .. 58 Deferred Revenue .. 58 Step-Up Considerations for Inventory .. 62 Overlapping Customers .. 66 Pre-Existing Relationships in a Business Combination .. 66 Asset Life and Amortization .. 67 Testing Outputs .. 70 SUMMARY .. 73 LIST OF ACRONYMS USED .. 74 REFERENCES .. 76 GLOSSARY .. 78 Glossary of Terms .. 78 Glossary of Entities Referred to in Document .. 82 APB VFR Valuation Advisory #2 - The Valuation of Customer -Related Assets 2016 The Appraisal Foundation 5 APPENDIX A: ATTRITION RATE CALCULATION EXAMPLES.