June 2006 Newsletter

Cap Rates

BIZCOMPS contains 9,000 purchase and sale transactions of small and very small businesses in many industries. An often-used metric from this data is the selling price divided by the Seller's Discretionary Earnings (the money available to the owner in the form of salary and earnings before interest, taxes, depreciation and amortization). While it is not appropriate to apply a general overall average to a specific transaction, it is interesting to note that the average of this metric for all transactions in BIZCOMPS is 2.0, and the median is 1.8. These figures equate to capitalization rates in the range of 50% when one looks at a comparable income stream in which the owner's salary has not already been deducted, such as is typically depicted on an individual tax return Schedule C (after reversing the effects of depreciation and amortization. However, capitalization rates are only applicable to the same level of income from which they have been derived. For example, the capitalization of an income stream after subtraction of owner's salary would require a lower cap rate, everything else being equal. The selection of a cap rate requires training and professional judgment. One figure does not fit all circumstances.

Harris County v. Inter Nos, Texas 1st Court of Appeals, 01-04-00736-CV

Harris County, Texas claimed the trial court improperly excluded evidence from its expert and improperly prevented cross-examination of Inter Nos's expert witness to elicit equivalent evidence. At issue in the case was a certain parcel of land to be valued that was encumbered by an easement. In his deposition, the County's expert reversed assumptions made in his reports regarding whether the easement had been abandoned, asserting that the easement had not been abandoned at the time of the taking. In this assertion, the expert lowered the value of the property being seized. Because disclosure of the new information was not timely, the Court of Appeals upheld the trial court's decision to exclude corrected testimony regarding abandonment of the easement. Moreover, the Court ruled the County could not introduce evidence through cross-examination that it had been forbidden from introducing through direct testimony.

New Rules for California CPA Practice Privileges

Effective January 1, 2006, out-of-state licensees that are providing services for California clients, including expert witness services, are required to file a Practice Privilege Notification form and pay a $100 practice privilege fee. Typically state rules require CPA's licensed out of state to obtain practice privileges in the state where they are testifying.

Fewer Complaints and Enforcement Actions Against CPAs in Texas

According to the May 2006 edition of the Texas State Board Report, complaints and sanctions have declined both in number and as a percentage of total licensees (Table 1). In FY01, 1.7% of Texas CPA licensees were disciplined. Applying the FY01 percentage to FY05 licensees, we would have expected over 1,000 sanctions; instead, there were only 613. Likely factors in this favorable trend include the peer review program and a strengthening of the requirement for continuing education in ethics.

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