Who should I ask for PPA? Differences between audit firm-affiliated, independent, and FA concurrently, and how to assess cost and quality

PPA requests, in other words, intangible asset valuations, can be requested from FAS companies affiliated with auditing corporations, independent valuation specialist companies/accounting firms, M&There are four types: A, FA, and in-house implementation. However, as a general rule, you cannot request your own audit firm (including FAS companies in the same network). The selection criteria is not the size of the organization. Does the track record of dealing with audit firms, the experience of the person in charge, and the deliverables (including calculation models) match the scale and complexity of the project (IFRS, multiple countries, necessity of valuation of movable assets)? Here are 7 questions to ask before getting a quote.

In this article, we will discuss the suitability and unsuitability of the four options for requesting a PPA, the reasons and basis for not requesting an audit firm, and how to assess cost and quality.

There are four types of PPA requests:

There are four main candidates for PPA requests, that is, candidates responsible for identifying and evaluating intangible assets:

1. Audit corporation-affiliated FAS (financial advisory services) company
2. Independent valuation specialist company/accounting firm
3. M&Concurrent duties by A's financial advisor (FA)
4. Implementation in-house (in-house production)

The first thing to check is that you cannot ask your own audit firm to do this.

You cannot request your own audit firm

When an audit firm provides PPA evaluation services to the company it audits, it will be responsible for auditing the amount of intangible assets that it has calculated itself. The Certified Public Accountants Act stipulates services that cannot be provided to large companies such as listed companies at the same time as audits (Article 24-2, Article 34-11-2 of the Certified Public Accountants Act,Article 5 of the Implementing Rules. (This includes work that is recognized as preparing the financial documents to be audited by the individual.)

Furthermore, the Ethics Rules of the Japanese Institute of Certified Public Accountants consider evaluation services that have a significant impact on financial statements to be a threat to self-reviews, and do not allow them to be provided to business entities with a high degree of social impact. This treatment generally extends not only to the audit firm itself, but also to FAS companies that belong to the same network. Even companies that do not fall under the category of large companies, etc. are usually treated in the same way from the perspective of auditor independence, so please check with your company's audit firm to see if this applies to you.

Therefore, if you request an auditing firm-affiliated FAS, you will choose a company with a different network than your own auditing firm. Additionally, audit firms may engage valuation experts from their own networks to review the results of valuations commissioned by the company. In this case, preconditions will be discussed between the company's evaluator and the audit firm's valuation expert.

Where to request PPA: Comparison of 4 options

Audit corporation FAS

There are cases where the target company has locations in multiple countries, involves complex transactions under IFRS (contingent consideration, non-controlling interests, step acquisitions), and involves large-scale valuations of movable and real estate. In these cases, the structure and overseas network of the auditing firm FAS is vital. However, the size of the organization does not guarantee quality, and as with other options, it is necessary to check the experience and involvement of the person in charge. It may be difficult to secure staff during busy periods.

Independent valuation specialist company/accounting firm

For small to medium-sized projects in Japan, independent companies are a strong option in terms of cost and flexibility. The person in charge is often directly in charge, and communication with the accounting department is quick. On the other hand, since there are large differences in structure and quality among independent companies, it is essential to check the track record of dealing with audit firms (which audit firms have they had experience negotiating with and on what issues) and the qualifications and experience of the person in charge. If you ask the same valuator to calculate the stock price, you can inherit the business plan and discount rate assumptions, making it more efficient in terms of both costs and time.

M&Concurrent post by A's FA

Since the FA who supported the acquisition is familiar with the details of the transaction, the identification of intangible assets can proceed quickly. However, from the perspective of independence, audit firms may express reservations about FA receiving success fees conducting evaluations. When requesting an evaluation from an FA, please check whether the FA has a specialized evaluation team separate from the transaction team, or whether the audit firm has given prior approval.

Implementation in-house (in-house production)

In the first place, accounting standards do not require the use of external valuation experts, and it is possible to conduct PPA in-house. However, the audit firm strictly verifies the assumptions and calculation process of the PPA as an accounting estimate. It is not easy to gather the necessary data and methods for evaluation in-house, such as a database of loyalty rates, discount rates by industry, and analysis methods for customer attrition rates. In-house production is only practical in cases where it can be reasonably explained that there are no significant intangible assets after examining the identification of intangible assets, or in cases where the difference between book value and market value is clearly small. In this case as well, it is important for audit purposes to document that the identification has been considered.

7 questions to ask before requesting a quote from a PPA client

Once you have narrowed down the candidates for your PPA, please check the following 7 points when requesting a quote. This is because these answers better represent the quality of the client than comparing prices.

1. First, are questions from the audit firm included in the estimate? Are there any restrictions on the number of times or period? Will you attend discussions with the audit firm's valuation experts?
2. Next, with which audit firm has the company had a track record of discussions on what issues (discount rate, useful life, royalty rate, customer churn rate, etc.)?
3. Also, who is in charge? How involved are partners and responsible parties? Qualifications and experience of the evaluator (certified public accountant, qualifications related to evaluation, number of PPAs).
4. What is the deliverable? Will a calculation model (Excel) be delivered in addition to the report? Can it be used for impairment testing in subsequent years?
5. Additionally, can you help me prepare a business plan? How should we proceed if we cannot collect materials from the target company?
6. In addition, experience in dealing with IFRS and cross-border projects. Discount rate for cash flows denominated in local currency, tax effect at local tax rate, availability of reports in English.
7. Finally, could I see a sample (anonymized version) of the report? Are the items checked by the audit firm covered?

What happens when you choose a PPA client based solely on price

PPA evaluations may be compared with figures independently estimated by the audit firm's valuation experts, and revisions may be requested if the explanation of the assumptions is insufficient. As a result, if the amount or useful life of an intangible asset changes significantly, the level of amortization expense and operating income for several years after the acquisition will change. You want to avoid a situation where you select an evaluator based solely on the difference in cost, and then the results change over and over again in discussions with the auditing firm, putting pressure on your closing schedule.

Conversely, there is no need to choose a client whose structure is too large for the scale of the project. Depending on the size and complexity of the case, and the attitude of the audit firm, choosing a client with a proven track record of handling audits and the experience of the person in charge will increase cost effectiveness.

How to proceed until deciding who to request PPA

1. First, consult with the audit firm about how to proceed with the PPA (identification policy for intangible assets, whether provisional treatment is necessary, whether or not the audit firm's valuation expert will be involved).
2. Next, based on the size of the case and the issues at issue (IFRS, overseas, whether movable property valuation is required), decide whether an audit firm-affiliated or an independent firm is more appropriate.
3. Then, request estimates from two or three companies by providing them with the outline of the transaction, outline of the target company, purpose of acquisition, accounting standards, existing materials, desired schedule, and scope of the request, and obtain answers to the seven questions above.
4. Finally, make a decision by comparing the amount, scope of work, conditions for handling audits, and experience of the person in charge, and confirming whether the system can meet the closing schedule.

summary

Requests for PPA can be divided into four types: auditing firm-affiliated FAS, independent valuation specialist companies, concurrently serving as FA, and in-house implementation, but requests cannot be made to your own auditing firm (including those in the same network). For example, FAS, which is affiliated with an auditing firm, is suitable for large-scale, multi-country, and complex IFRS projects, while independent auditing companies with a solid track record of handling audits are suitable for small to medium-sized domestic projects, in terms of the balance between cost and quality. Therefore, when making a selection, it is important to check the conditions for dealing with an audit firm, the experience of the person in charge, deliverables, and the content of the report rather than the amount.

Things you can discuss with Keystone Advisory

Keystone Advisory is an independent advisory service run by certified public accountants. In addition to PPAs for domestic projects, we also evaluate intangible assets and support audit firms for cross-border projects, such as the acquisition of an Indonesian company by a Japanese company. We will answer the above seven questions at the first meeting, so please contact us as one of the companies you are considering to compare PPA requests. We also accept consultations on how to read estimates and report samples from other companies.Contact formPlease let us know the outline of the project.

References

Certified Public Accountants Act Enforcement Regulations (e-Gov Law Search)

Accounting Standards for Business Combinations (Corporate Accounting Standards No. 21)

Writer

Kensuke Tanabe (CPA)

Keystone Advisory

Engaged in valuation/PPA work, statutory audits, and IPO support at Tohmatsu Audit Corporation and PwC Advisory. He assumed his current position after working as a director at a PE fund and an issuer at an operating company.

*This article is an explanation of general practice at the time of writing. Please check with each company's audit firm for individual judgments regarding the independence of the audit firm.