Debunking the Cost Approach Bunk, Part 2

August 29th, 2011 | Cost Approach | Healthcare Reform | Regulatory Matters | Valuing Goodwill

Among the many misconceptions argued in the Valuation Strategies piece entitled Valuing Physician Medical Practices is that somehow other appraisers are inconsistent when attaching value to tangible assets such as furniture and equipment while at the same time attaching no value to intangible assets

If you were not engaged in healthcare valuation in the 1990s or failed to study the history and pronouncements that came out of that period of physician practice consolidation, perhaps you would be unfamiliar with the letter from then OIG Associate General Counsel D. McCarty Thornton to the American Hospital Association.  The following quotes are from

“The following are specific aspects of physician practice acquisition or subsequent activities that may implicate or result in violations of the anti-kickback statute. Our comments focus primarily on two broad issue categories: (1) the total amount paid for the physician practice and the nature and type of items for which the physician receives payment; and (2) the amount and manner in which the physician is subsequently compensated for providing services to patients.(2)

“When considering the question of fair market value, we would note that the traditional or common methods of economic valuation do not comport with the prescriptions of the anti-kickback statute. Items ordinarily considered in determining the fair market value may be expressly barred by the anti-kickback statute’s prohibition against payments for referrals. Merely because another buyer may be willing to pay a particular price is not sufficient to render the price paid to be fair market value. The fact that a buyer in a position to benefit from referrals is willing to pay a particular price may only be a reflection of the value of the referral stream that is likely to result from the purchase.(3)

“… Specific items that we believe would raise a question as to whether payment was being made for the value of a referral stream would include, among other things:

— payment for goodwill,

— payment for value of ongoing business unit,

— payment for covenants not to compete,

— payment for exclusive dealing agreements,

— payment for patient lists, or

— payment for patient records.

Payments for the above types of assets or items are questionable where, as is the case here, there is a continuing relationship between the buyer and the seller and the buyer relies (at least in part) on referrals from the seller.”

Thus, since 1992, it has been incumbent upon the appraiser from the standpoint of a jurisdictional standard of value to view tangible and intangible assets differently; this different view has been expanded in the Stark regulations with reference to general market value and commercial reasonableness, among others, as well as in numerous Internal Revenue Service publications linked elsewhere in this BLOG.

I believe that SSVS of the AICPA, to which all CPAs are required to adhere, requires consideration of the jurisdictional difference here as well, as shown in the following extract:

“Jurisdictional Exception 10. If any part of this Statement differs from published governmental, judicial, or accounting authority, or such authority specifies valuation development procedures or valuation reporting procedures, then the valuation analyst should follow the applicable published authority or stated procedures with respect to that part applicable to the valuation in which the member is engaged. The other parts of this Statement continue in full force and effect (Valuation Services Interpretation No. 1).”

Given that there are numerous modifications to the standard of fair market value for physician practice transactions, the general requirements of fair market value have to be understood by the appraiser as well.  Another misconception held by the authors of this piece is that there is no apparent difference between the going concern and liquidation premises of value. To aid in understanding the different treatment of fixed assets, working capital assets and intangible assets, I have developed the following flowchart:

Liquidation Value Chart

I believe the Chart is self-explanatory, but suffice it to say here that the premise of value drives the determination of the value of the various classes of assets, and going concern value and liquidation value generate different results, except typically for working capital.  And, in all events, the determination must be driven by the need to exclude from the value any consideration of the ability of the transacting parties to refer to one another.

I’ll be back.

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