Abuse of the Cost Approach

May 29th, 2010 | Income Approach & Methods | Medicare | Valuing Goodwill

This topic is more like one of the Zombies in Night of the Living Dead as opposed to the arguably cute Eveready Bunny; nonetheless, it keeps on goin.'

It has come to my attention that one reason for the inaccurate, improper and altogether wrong use of the Cost Method to value physician practices for hospital acquisition is due to the fact that the version of the 1996 IRS EO CPE text on Valuation of Medical Practices ( eotopicq96.pdf at http://www.irs.gov/pub/irs-tege/) does not contain Exhibits A and  B which are referenced therein – and quite clearly (let me say it again, QUITE CLEARLY) demonstrate that Business Enterprise Value was determined using the DCF Method under the Income Approach (that's the Income Approach, Beavis) not the Cost Approach. The Cost Approach was only used to allocate the Intangible Value determined under the Income Approach to specific intangibles, as is clearly stated elsewhere in the document, to wit: "The value of goodwill can be allocated to specific intangible assets; the value of the latter is limited to the value of the former, as calculated under the income approach. For example, if the total value of the individual intangible assets exceeds the total value of the medical practice net of the aggregate fair market value of the tangible assets, the amount of value that can be allocated among the intangible assets is more limited. Also, it is important to note that intangible value may not always be present in a medical practice."

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