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."

Business Valuation Resources will be publishing a new book Guide to Valuing Physician Practices containing principal contributions by me along with several other authors on valuing medical practices, including a detailed look at various analytical approaches to such factors as CPT codes, RVUs, Technical Component Revenue and MGMA data. Here is the link

http://www.bvresources.com/physicianvaluation

The current wave of practice acquisitons by hospitals after a hiatus of some 10 years has caused some of us who were witnesses to the last cycle of acquisitions, which ended in the 1990s, to look at the historical lessons learned.

As anyone familiar with hospital admissions knows, orthopedics and cardiology are the two specialties that account for the largest share of hospital admissions. They also tend to be the most proftable as the plethora of for-profit surgical specialty hospitals would suggest. For those readers not familiar with this,  http://www.merritthawkins.com/pdf/2007_Physician_Inpatient_Outpatient_Revenue_Survey.pdf contains the 2007 survey by physician recruiting firm Merritt Hawkins about revenue contribution by specialty. Thus, it is not surprising that the principal acquisition target of many hospitals is cardiolgy practices. Whether it be the Cardiac Intensive Care Unit (CCU), open heart surgery, blood chemistry lab, SPECT, ultrasound, cardiac CT or MR, cardiovascular admissions are the lifeblood of most hospitals.

My BLOG post http://cpanet.typepad.com/cpanet/2006/11/umdnj.html about this time 3 years ago was a result of stories in the trade press including Daily Dose about the Community Cardiology Program established at the University of Medicine and Dentistry in New Jersey when its accreditation for cardiac surgery was threatened due to insufficient surgical volume. The link to the Monitor's Report in that post is no longer valid, the Report can now be found here http://www.umdnj.edu/ethweb/federalmonitor/index.htm. You can follow the links yourself to see what happened, but there were a number of fines and criminal guilty pleas. Also of some interest, as my original BLOG post noted, is the e-mail record that then US Attorney - and now Governor-elect of New Jersey - Chris Christie obtained.

I have long-advised my colleagues in writing, lectures and personally that as a healthcare appraiser you are not a lawyer, but you best have a sufficient understanding of tax exemption, Stark, the AKS, False Claims Act, antitrust and administrative sanctions to enable you to make a reasonable evaluation of the regulatory underpinnings of a proposed acquisition as well as to assess the representations of any legal counsel involved in the acquisition. And, if you feel your personal knowledge base is short, seek your own, independent, legal counsel.

Looking at my Post http://cpanet.typepad.com/cpanet/2009/12/shades-of-future-past-.html earlier this month, it seems that knowingly, or unknowingly, attempting an end run around the longstanding regulatory and, indeed, professional literature on when the replication cost approach is appropriate is not a particularly good idea, at least when it comes to cardiology practices.

I updated yesterday's post to clarify that the Cost Approach was not appropriate for valuing Intangibles unless there was value under the Income Approach – a reader caught that miss before I could get to it this AM. As to other assets like equipment, value is typically paid based on the fair market value under a Cost Approach rather than the Income Approach. In those cases one needs to look at the premise of value – as part of a going concern, as part of a mass assemblage of assets, etc.

…or more accurately, Through the Past Darkly. Other cliches that come to mind: History Repeats Itself and PT Barnum was Right.

Despite a well-established regulatory construct that dates back to the IRS CPE Texts in the early 1990s, using the Cost Approach to value practices for acquisition by hospitals is back in fashion again, primarily by healthcare-appraiser wannabes. Less there be any misunderstanding, unless there is value under the Income Approach as determined from a well-reasoned DCF, use of the Cost Approach to value Intangibles is not appropriate, period. That's a PERIOD. What could be clearer than the Derby case?

Here are prior posts that summarize the Rules

http://cpanet.typepad.com/cpanet/2009/06/ahla-tax-finance-practice-group-member-briefing.html
http://cpanet.typepad.com/cpanet/2009/03/exempt-organization-cpe-text.html
http://cpanet.typepad.com/cpanet/2008/10/derby-et-al-v-commissioner.html
http://cpanet.typepad.com/cpanet/2007/10/post-transactio.html
http://cpanet.typepad.com/cpanet/2006/11/umdnj.html (!)

My October 10, 2007 discussed the several IRS CPE Texts that are relevant to valuing physician practices for purchase by hospitals or Integrated Delivery Systems. I should have mentioned an obvious one there, the 1996 EO CPE Text Valuation of Physician Practices (eotopicq96.pdf). Look at the discussion beginning at the bottom of page 22 and particularly that on page 23 with respect to Medical Records. This is where the IRS first made it clear that you had to have intangible value under the income approach before the cost approach became relevant. In my view, that is true anyway but particularly so in light of Derby, discussed elsewhere on the BLOG.

You can obtain eotopicq96.pdf at http://www.irs.gov/pub/irs-tege/.