KPMG FORUM. Quarterly contains articles written by KPMG experts in Poland who explore the challenges and problems arising in their daily work. kpmg.

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1 ISSN 2299/6206 KPMG FORUM Quarterly contains articles written by KPMG experts in Poland who explore the challenges and problems arising in their daily work. kpmg.pl nr

2 2 KPMG Forum Editorial office: KPMG Sp. z o.o. ul. Chłodna Warszawa T: F: kpmg.pl Editor in Chief: Magdalena Maruszczak Supervising editor: Anna Gajewska-Płomińska Design studio: KPMG Sp. z o.o.

3 KPMG Forum 3 TABLE OF CONTENTS Continuous Auditing and Continuous Monitoring Krzysztof Radziwon... 6 The management report: what s in store? Agnieszka Müller-Grządka... 9 Investments in medicine continued Anna Zientkiewicz...12 Option to defer amortization or decrease amortization rates Monika Jasińska, Michał Lejman...14 Valuations prepared by Polish stock brokers vs. best practices of mature markets Tomasz Wiśniewski, Jacek Komór... 18

4 4 KPMG Forum KPMG offices in Poland Warszawa ul. Chłodna Warszawa T: F: E: Kraków al. Armii Krajowej Kraków T: F: E: Poznań ul. Roosevelta Poznań T: F: E: Wrocław ul. Bema Wrocław T: F: E: wroclaw@kpmg.pl Gdańsk al. Zwycięstwa 13a Gdańsk T: F: E: gdansk@kpmg.pl Katowice ul. Francuska Katowice T: F: E: katowice@kpmg.pl Łódź al. Piłsudskiego , Łódź T: F: E: lodz@kpmg.pl kpmg.pl firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in Poland. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. Printed on recycled material Cyclus Print

5 KPMG Forum 5 Experts contributing to the issue 4/2013 Krzysztof Radziwon Agnieszka Müller- Grządka Anna Zientkiewicz Tomasz Wiśniewski Jacek Komór Monika Jasińska Michał Lejman kpmg.pl youtube.com/kpmgpoland twitter.com/kpmgpoland facebook.com/kpmgpoland

6 6 KPMG Forum Audit Continuous Auditing and Continuous Monitoring In accordance with the definition, internal audit should apply a disciplined approach towards the assessment and improvement of the effectiveness of risk management, control and supervision. The phenomena of internal audit evolves, similar to the evolving requirements imposed by regulating entities and company owners which companies have to face and as a consequence the requirements which are formulated by boards of managements in front of persons responsible for the functioning of the particular area of company activity. The foundations of Internal Audit functioning remain unchanged. The superior goal of the function is constituted by the independent assessment as well as advisory within the scope of the functioning business processes, the quality of the internal control environment as well as risk management within the organisation. Similarly unchanged remain the guidelines which point to the requirement that in the process of planning of its activity internal audit should take the periodically executed risk analysis into the consideration. What is subject to experiencing changes is the surroundings within which the internal audit operates. The aforementioned refers to both market competition, suppliers, market regulators or legislators. The spectrum of problems and risks associated with the above which should be devoted attention by the internal audit is extremely broad. On the other human resources remaining at the disposal of such functions in the process of recess are not usually subject to increase. The fact that has been pointed to by the observers of the crisis was that frequently internal auditors were too much centred on operational aspects of the functioning of companies, instead of devoting more time to strategic issues as well as risks associated with the aforementioned area. The aforementioned crisis, the trademark of which has been constituted by the fall of Lehmann Brothers has with great strength shown that what is important are not only details, but above all comprehensive assessment of the level of risk associated with the conveyed entrepreneurship activity and rational assessment of the capability of the company to cope with such risk. At the level of risks embedded into particular processes the problems looming ahead were not clearly visible, nevertheless careful observers could spot the upcoming problems at the level of strategic risks. The assumption to be drawn is that one should not forget about keeping an eye upon the organisation through the perspective of strategic risks while paying attention to details. In accordance with the definition, internal audit should apply a disciplined approach towards the assessment and improvement of the effectiveness of risk management, control and supervision. Therefore one of the key tasks presented in front of audit and therefore one of the key expectations of internal audit is for the

7 Audit KPMG Forum 7 process to ensure adequate protection against threads and hazards looming ahead. This goal may be achieved by employing adequate resources as well as time and competence in order to analyze the strategic layer of the functioning of a company. Nevertheless, the analysis of strategic problems may not be executed at the cost of audit of operational activity being executed by the company. Within the context of limitations associated with the number of personnel employed within internal audit teams, this problem could be to a significant extent resolved through the application of tools enabling Continuous Auditing and Continuous Monitoring, i.e. the referred in the title of the hereby article CA/CM. CA/CM Quintessence is constituted by the conveyance of continuous (also in real time) supervision over the processes executed with the support of available IT systems. In contemporary banks in general the majority of processes is executed with the support of IT technologies. What would such continuous supervision or monitoring be connected to? It is connected to the definition of particular parameters within tools responsible for the execution of continuous audit, the aim of which is the compare the attained results to the expected value. Example? If the determined goal within the scope of customer care is constituted by the processing of a submitted request within 48 hours, the system shall analyse all occurrences of the registration of the request along with the further monitoring of time within which the request is being processed. If the aforementioned amount of time should surpass 48 hours, the applicable information may be sent to persons responsible for the whole process, moreover the system will record the given transaction as audit proof which shall be applied for the assessment of operative effectiveness of control mechanisms. It is not indispensable that the management is to be notified about every delay by the system, such aspects should be subject to adequate setting and determination of parameters. Notifications may be sent onto the hands of upper management in the situation when the total number of delays should surpass border value and start to be problem for the quality of the whole process. Other examples? Execution of payments prior the expected deadline or after the payment deadline has become extinct, identification of orders close to authorisation borders for a single supplier, identification of double payments, analysis of delays within the repayment of instalments by clients, too great quantity of entries into restricted access zones (for instance: server room). The general principle is very simple if the given process is serviced by the system and its quality parameters had been defined, the tool responsible for the continuous audit and monitoring should allow and enable for the ongoing monitoring of the quality of such processes. Internal audit in its classic form to a significant extent centres around testing control mechanisms as well as testing of transactions and occurrences. The first step in the process of implementation of continuous audit should be constituted by the implementation of adequate tools within the areas characterised by the large number of transactions/ occurrences the fact that will allow for the reception of insight into the quality of the process based upon the parameters of all of the transactions hence not only based upon the analysed sample. Additionally, access to such information will be offered not when there should come time for the examination of the given areas in accordance with the plan of audit, Internal audit in its classic form to a significant extent centres around testing control mechanisms as well as testing of transactions and occurrences. The first step in the process of implementation of continuous audit should be constituted by the implementation of adequate tools within the areas characterised by the large number of transactions/occurrences the fact that will allow for the reception of insight into the quality of the process based upon the parameters of all of the transactions hence not only based upon the analysed sample.

8 8 KPMG Forum Audit but with the application of current and ongoing basis. Access to such information will also allow for the ongoing identification of such points within the processes where something starts to function not in the required manner and will allow for adequate reaction. The high level concept of the functioning of CA/CM tools is presented upon the below diagram. Krzysztof Radziwon KPMG Partner with Risk Consulting practice KPMG in Poland Has over 15 years of diverse public accounting, internal auditing, information systems auditing and risk management experience. Currently is responsible for the Risk Management Services including internal audit sourcing and assessment, enterprise risk management system design and implementation, systems compliance, internal control systems design and assessment including continuous auditing as well as attestation services. For the past 12 years he has been heavily involved in reviews and design of internal control environment including business and IT processes. Sector experience includes telecommunication, banking, insurance, industrial and consumer markets. Krzysztof holds designations from Association of Chartered Certified Accountants (FCCA), ISACA (Certified in Risk and Information Systems Controls, Certified Information Systems Auditor). High level CA/CM tool operation concept Transaction data Source data Non-standard data Other data ERP, CRM transaction systems as well as other systems responsible for the organisation and execution of processes Information from s, reports, access systems, etc. Data from non electronic sources (for instance from application forms or templates) Extract, Transform Load (ETL) Tools Data processing Database Applications server Data repository Important CA/CM components Principles created as part of the CA/CM approach (i.e. what is to be reported) Data sources for CA/CM tool feed (i.e. where is the data take/originating from) The principles of /text message notification for expert auditors and the management Summary of dashboards and drill-down tools for expert auditors and the management Information Standardized reporting Control, exception and KRI dashboards Dashboards in standardized form allow for the current monitoring of effectiveness of control as well as of the current process parameters Reason and effect analysis Drill-down functionality allowing for the identification of the reasons of divergences from the expected values as well as from exceptions Alerts and notifications Notification systems based upon s and/or text messages Excel datasheets PowerPoint Presentation display Laptop/Desktops Reports Mobile devices

9 Audit KPMG Forum 9 The management report: what s in store? Management report represents an important element of an entity s communication with equity markets. It offers the opportunity for management to explain the entity s goals and strategies, and also provides context to users who wish to interpret the financial position and results of the entity. Developments in the area of financial reporting accelerated recently so let s take a closer look at the changes. On 12 June the European Parliament approved the proposed new directive on annual and consolidated financial statements as well as related reports of certain types, which in the near future shall replace both the Fourth Directive on annual financial statements and the Seventh Directive on consolidated financial statements (the Directives ). In use for the past thirty years, the Directives appear to have lost their relevance despite periodical modifications. That said, with regards to financial reporting itself the new Directive does not introduce any significant changes. The ones proposed are primarily to enhance the clarity of the regulations, with two issues requiring particular attention as discussed below. It is good to be micro The first of the above issues relates to various reliefs applicable to so called micro entities as included in the 2012/6/EU Directive dated 14 March Member states are provided with an opportunity to introduce certain exemptions which will reduce the financial reporting obligations of this category of entities, including the elimination of the requirement to prepare management reports. Micro entities are those not exceeding two out of three of: Gross assets: EUR, Net turnover: EUR, Average headcount: 10 persons. Micro entities may be relieved from the requirement to prepare their management reports provided that they are not in breach of another EU Directive on the protection of the shareholders rights. Accordingly, if the information on purchases or sales of own shares during the year, so far presented within the management report, is disclosed in the notes to the financial statements the management report will not be mandatory. In our view, exempting micro entities from the obligation to prepare management reports is rational and justified considering the scope of their activities and the ease with which they communicate with shareholders and other stakeholders. In practice management reports of micro entities are very often viewed as an exercise in compliance, and are limited to several pages with just a few sentences on each of the topics required by the Accounting Act.

10 10 KPMG Forum Audit The exemption will not apply to publicly listed entities irrespective of the size of their activities. The proposed exemptions may require changes not only to the Accounting Act but also the Commercial Companies Code ( CCC ). One needs to bear in mind that under the CCC, the management report, referred to as the report of management on the company s activities or the report of general partner on the company s activities, respectively, for commercial companies and limited joint stock partnerships (spółki komadytowo - akcyjne) not only need to be reviewed and approved by the general meeting of shareholders but are also generally considered a basis for the shareholders vote of approval of the management board or general partners. It is also our expectation that the relief, once implemented in Poland, will not be limited to commercial companies and limited joint stock partnerships that meet the micro entity definition (and to which the Directive applies directly), but that it will also encompass the micro entities in the form of societies, state owned entities and mutual insurance companies. The exemption will not apply to publicly listed entities irrespective of the size of their activities. Management report in the auditor s opinion The second important issue relates to the proposed expanded language in the auditor s opinion in respect of the management report. In accordance with the new Directive, the auditor s statement on the consistency of the management report with the underlying financial statements and its compliance with applicable legal requirements would be extended to include a confirmation as to whether in the light of the knowledge and understanding of the entity and its environment obtained in the course of the audit the independent auditor has identified material misstatements in the management report. For any such misstatements identified, the auditor will be required to provide further details as to their nature. Extension of the scope of the auditor s opinion does not mean that she or he has so far not paid any attention to misstatements within the management report. This aspect is currently addressed depending on the nature of the issue as part of the auditor s assessment of the consistency of the report with the financial statements, or of compliance with the applicable provisions of the law. Upon the introduction of the change the opinion of the expert auditor will simply obtain greater clarity. Not only the European Directives NWhile waiting for the implementation of the Directives two other documents aimed at improvements in the quality of management reports may be worth reading. The first of the documents is the IFRS Practice Statement Management Commentary. A Framework for presentation issued by the International Accounting Standards Board (IASB) in December 2010 ( IASB Statement ). The IASB Statement is not an accounting standard (and thus there is no legal requirement for it to be applied) nor is it a set of rigid rules based upon which a management report is to be prepared. Nevertheless it does include general principles, quality characteristics and content of a commentary which have been considered as indispensable in order for the users of financial reports to receive useful information. The goal of the IASB Statement is to support management in increasing the usefulness of the management commentary to financial statements prepared in accordance with International Financial Reporting Standards. The form and content of the management commentary depends

11 Audit KPMG Forum 11 upon an entity, but information disclosed should be adjusted to the needs of primary users of the financial reports, i.e. existing and potential investors, lenders and other creditors. The basic principles of presentation of management commentary seem to be obvious. First of all, the commentary is to present the management views on the entity s performance, its financial condition as well as its progress. Secondly, it should supplement and complement the financial statements. What is meant by the usability of information presented within the management commentary? The information should be relevant, material and faithfully represent the issues described. Further, to the greatest extent possible, the information should also be comparable, verifiable, timely and understandable. All of the above is aimed at the presentation of the past, present as well as future of the entity through the eyes of its management. The second document is a draft of the National Accounting Standard Nr. 8 Report on the entity s activities exposed for public comments in June 2013 ( Standard ). According to the Accounting Standards Committee, the Standard is consistent with the provisions of both the Accounting Act and the IASB Statement. In certain areas however the Standard provides a broader perspective and its general principles are laid out in a more authoritative manner. Of particular importance is the fact that both documents generally share the same goal: formation of good practises for the preparation of management reports that would be perceived as documents co-existing with the financial statements and not as separate documents with their own unnamed goals. The Standard may be applied by all entities obligated to prepare a management report pursuant to the provisions of the Accounting Act. It Agnieszka Müller-Grządka DPP Director KPMG in Poland from 1994 to 2007 worked in the Audit Department where she was responsible for examination of financial reports of companies from various sectors of the economy; From 2007 in DPP; From 2007 the member within the National Council of Expert Auditors (KRBR) committee with regards to opinioning of legal deeds may also be applied by other entities, which, under their applicable laws, need to prepare such reports (for instance foundations, investment funds and pension funds). In comparison to the IASB Statement the users of the management report has been defined in the Standard more broadly and includes such stakeholders as owners, investors, lenders and other creditors, clients, suppliers and cooperating agents, employees, local societies and supervisory bodies of public administration. Providing information that would be useful to so many different users may prove to be a challenging task and consequently the end result may also be confusing. A narrower definition of users within the Standard would allow the preparers of the management report to put more focus on its quality and the proper presentation of forward looking information which is so often referred to within the Standard and the IASB Statement.

12 12 KPMG Forum Audit Investments in medicine continued Medical market in Poland We are currently witnessing the hottest period on the Polish mergers & acquisitions (M&A) market in the medical industry. For several recent months the M&A activity has been shadowed by EUR 400m worth acquisition of the Lux Med Group, nevertheless it is not all that had taken place within the industry. Medical services providers were the subjects of over 20 equity transactions, that were executed in Poland, from 1st January 2012 until the 30th June 2013 (not including spas, pharmaceutical companies or medical equipment manufacturers and distributors). PEs Pushing Ahead PLike in previous years, M&A transactions within the healthcare industry were above all driven by financial investors Private Equity ( PE ) as well as mutual fund managers ( TFI ) investing through stock exchange markets. The buy and build strategy adopted by MidEuropa Partners at Lux Med is common to the majority of other Private Equity investors on the Polish market. Therefore, we have observed two types of transactions with the support of PE the purchase of a platform for further development by those investors who are just entering the sector, as well as add-on acquisitions, aimed at consolidation with previously acquired portfolio companies. Good example of add-on acquisitions were those done by the Lux Med Group. Only in 2012, while still owned by Mid Europa Partners, did the Lux Med Group finalise four transactions. The deals aim was to broaden the client base (purchase of MegaMed) or to extend the portfolio of offered services (diagnostic imaging part of the Swissmed hospital, mammography part of Św. Jerzy centre and Endoterapia Sp. z o.o.). American Heart of Poland (since 2011 controlled by Advent International) invested in Carint Scanmed and in Med-Pro. At the same time, Enterprise Investors ( EI ) entered a new market segment and decided to concentrate on oncology. In 2012, EI purchased shares in Centre for Oncology Diagnostics and Therapy (Centrum Diagnostyki i Terapii Onkologicznej) from the listed Voxel, while in March 2013, EI acquired Nu-Med based in Elbląg. Innova Capital has decided to financially support Ujastek maternity hospital and soon announced further investment in a gynaecology and obstetrics ward in Chorzów. Finally, what should not be forgotten is the fact that, apart from Lux Med, Mid Europa Partners is still in the process of active development of another group within the sector of laboratory diagnostics. Among others, in autumn 2012 the fund purchased Alpha Medical, from a regional industry player Penta Investments. In the nearest future we may expect further investments executed by all of the aforementioned consolidators. Talking about the sale of Alpha Medical, it should be observed that within the last few months a few large exits from Private Equity investments took place, unlike in few preceding years, when funds were focused rather on buying. Apart from the disposal of Lux Med by MidEuropa, Penta sold Alpha Medical laboratories and ARX Private Equity sold the chain of ophthalmology clinics Lexum to Moonray Healthcare. Apart from Private Equity funds, the industry is also being screened by a few TFIs, who usually take minority stakes in stock exchange listed companies. The aforementioned group is led by TFI PZU or by Investors TFI fund. The latter player acquired among others, a new share issues in Scanmed and Voxel. Turning attention to the engagement of industry investors: with the exception of strategic investment of BUPA, the strategic buyers activity was definitely much smaller. The rare examples of other transactions without the support of Private Equity include the takeover of a fertility treatment clinic InviMed by Medicover.

13 Audit KPMG Forum 13 This particular transaction is worth attention because until now In Vitro clinics have been outside of investors attention, whereas now they may turn out to be one of the more attractive specialities enjoying a significant growth perspective considering the new possibilities of public funding of these procedures. It is worth noting that despite the number of speculations insurance companies do not make strategic buys in the sector (with the exception of BUPA). The only player who has decided to build its own medical centre Signal Iduna, has just made a decision to sell the investment. Lux Med Effect Coming back again to the sale of Lux Med, let us take a closer look at the effects evoked by the transaction upon the whole market. Reaching the EUR 400m value it was not only the largest transaction within the medical industry in Poland, but also one of the largest PE deals on our market. Most visible effects of this deal included the increase of share prices of the listed medical companies and the increase in the number of announced transactions within the sector. Companies owners count on taking advantage of the heated up market, and achieving higher price for their business. Nevertheless as Private Equity funds point out, elevated price expectations of sellers are frequently not supported by any rationale and in effect deters the buyers from equity moves. Moreover, after BUPA had entered the market, the majority of investors lost interest in the medical subscription segment, as it is considered that cards have already been dealt. Therefore, despite appearances, the hot market effect does not have to result in a greater number of transactions. Specialization, hospitals and PPP As it had already been observed in previous years, the majority of financial investors tend to choose smaller entities with an interesting specialty, characterised by strong demographic and epidemiologic basis for further development. Also such therapeutic areas are taken into consideration, which offer attractive pricing of medical services. Therefore, privately owned medical centres often face accusations of taking away the most attractive services from public entities and not being able to ensure comprehensive medical care. Considering the above, we are also currently observing a breakthrough transaction the acquisition of EMC Instytut Medyczny by Penta Investments. So far comprehensive hospitals were rather cautiously approached by the majority of investors, especially considering the organisational complexity of such entities, the necessity of restructuring as well as greater medical risk and probable longer payback period. Penta s move shows that there is room for a financial investor also in this sector. Moreover, there are other interesting formulas of engagement for financial investors within the public hospital sector. Joined KPMG in 2006 The above mentioned Innova Capital s investment in the city of Chorzów encompasses the construction of a new ward in co-operation with a public hospital institution, in this case with Zespół Szpitali Miejskich (Municipal Hospitals) in Chorzów. Similarly in the case of Centre for Oncology Diagnostics and Therapy (Centrum Diagnostyki i Terapii Onkologicznej) in Katowice, Voxel and Enterprise Investors realize a project on the premises of the Clinical Hospital number 5 of the Medical University of Silesia. The Bródno Hospital has chosen a private partner for the construction of the radiotherapy centre, the same move is planned by the hospital in Olsztyn as well as by other centres all over Poland. Considering still large investment needs within the Polish healthcare sector we should expect further projects based upon the co-operation of public entities with private investors to become much more widespread. To sum up the engagement of financial investors within medicine is gradually moving from the segment of relatively simple activity in outpatient care towards more complex medical specialties, hospital activity as well as towards more refined transaction structures, engaging various public entities. This trend is likely to continue in the future. Anna Zientkiewicz Manager Mergers & Acquisitions Consumer and Industrial Markets, Corporate Finance Group KPMG in Poland Has over 6-years experience in projects related to mergers and acquisitions of companies Specializes in advisory to companies form consumer goods and healthcare sectors Since Anna joined KPMG she has been involved in various M&A transactions as both buy and sell-side advisor; she participated in identification of investment targets and potential investors, preparation of transaction documentation and final negotiations. She has also participated in preparing strategic and market analyses, feasibility studies and valuations.

14 14 KPMG Forum Tax Option to defer amortization or decrease amortization rates In principle provisions of the CIT Act 1 do not predict the possibilities of categorizing incurred expenses on the acquisition of the fixed assets directly to tax deductible costs. However, as a rule depreciation allowances made from the initial value of these fixed assets will be recognized as tax deductible costs. Taxpayers who obtain fixed assets make choice of one of depreciation method for individual fixed assets before beginning its depreciation. The chosen method is applicable to full depreciation of given fixed assets. Decreased amortization rates can be applied for fixed assets that are amortized with a straight-line amortization method. Taxpayer is entitled to decrease amortization rates down to any level, including level 0% - in fact such a decision results in deferring the depreciation. Above regulations enable taxpayers to get the influence on the amount of the taxable income or the created loss in the given tax year. Taxpayers may plan lower depreciation allowances in the period in which they predict that activity conducted by them will generate losses (so that the loss is not growing). Moreover, for the purpose of the full exploitation of the tax exemption, possibility of reducing amortization rates can be use also by taxpayers conducting business activity within the territory of special economic zones based on obtained permits. Deferring amortization (reducing amortization rates) can concern all fixed assets or fixed assets freely chosen by the taxpayer and it is not dependent on deferring physical consumption of fixed assets Moment of applying decrease amortization rates In case of fixed assets possessed by the taxpayer and included into fixed assets account decreasing amortization rates can be applied starting from the first month of tax year following the year in which the decision on decreasing rates was made. However in case of fixed assets which will be introduced into fixed assets account in the future 0% amortization rates can be applied starting from the month in which these assets are included into fixed assets account Amortization rates increased by additional coefficient In case of straight-line amortization method taxpayer is entitled (not obliged) to increase rates by coefficient amortization rates resulting from Specification because of special conditions described in CIT Act (e.g. bad, deteriorated conditions, fast technical progress etc.). It means that only maximum rates resulted from Specification can be increased with a coefficient while, at the same time, it is not possible to increase with a coefficient rates already decreased (i.e. rates lower than maximum rates resulted from Specification). It is also not possible to decrease amortization rates that have been already increased with a coefficient. In order to decrease (even down to 0% level) amortization rate that had been already increased with a coefficient defined for a given fixed asset taxpayer shall first make a decision to cease applying coefficient and only then make a decision to decrease amortization rate defined in Specification for a given fixed asset. Depreciation period Pursuant to the provisions of the CIT Act, depreciation allowances are made to the moment of leveling the sum of depreciation allowances with their initial value.

15 Tax KPMG Forum 15 In connection with decreasing amortization rate (even down to 0%) applied for fixed assets included into fixed assets account amortized with a straight-line method, amortization period changes. This period will be: extended if amortization rates are higher than 0% but lower than applied so far, or postponed if 0% amortization rate is applied and then fixed asset is amortized with the rate applied so far. As results from the above, period of amortization with a straight-line method depends on the applied rate. Deferring amortization is thus possible in case of fixed assets with any amortization period. Investment in foreign fixed assets General rules related to deferring amortization / decreasing amortization rates refer particularly to investments in foreign fixed assets amortized by taxpayer. It should be stressed that amortization deductions from the value of investment in a foreign fixed asset are not tax deductible costs in this part in which taxpayer received return on investment. Having the above in mind, if amortization deductions calculated from investment in foreign fixed assets would not, as a whole, constitute tax deductible costs for the taxpayer, it is not advised to defer amortization / decrease amortization rates since it would not influence tax settlements of the taxpayer in any way. Financial leasing General rules related to deferring / decreasing amortization rates also refer to assets that are subject to financial leasing. As a rule, fixed assets subject to financial leasing in which a straightline method is used shall be amortized with a rate not higher than a maximum rate defined in Specification. In case, if after term of lease the ownership is transferred to lessee, he makes further amortization deductions in accordance with the rates and methods resulting from leasing contract. In such a case taxpayer can consider deferring amortization (or decreasing amortization rates) for the set period of time. In case of leased fixed assets, towards which taxpayer does not assume to take full ownership, deferring amortization does not bring any tax advantages, since the taxpayer will incur financial cost of payments without classifying tax deductible costs as amortization deductions. After leasing is terminated it would be not possible to recognize tax deductible costs which identification was deferred during the term of lease. Independently on the above, it shall be emphasized that in case of deferring amortization / decreasing amortization rates the interest part of leasing rental will invariably constitute tax deductible cost for the taxpayer. Maintenance of fixed assets As a rule, entities are not obliged to keep fixed assets for a certain period of time (e.g. for longer than it is useful for business activity). This is why a fixed asset can be liquidated/sold at any moment convenient for the taxpayer, even if it had not been fully amortized yet. If a fixed asset, for which amortization rate had been earlier decreased, is sold or liquidated (for other reasons than changing the type of business activity) taxpayer will not suffer negative economic consequences. Taxpayer will be entitled to include in tax deductible costs this part of Taxpayers who obtain fixed assets make choice of one of depreciation method for individual fixed assets before beginning its depreciation. The chosen method is applicable to full depreciation of given fixed assets.

16 16 KPMG Forum Tax expenses for fixed assets that had not been allocated to tax costs by means of amortization deductions. Option to resume amortization/ increase amortization rates As we indicate above chosen method of amortization for particular fixed assets is applied until a given fixed asset is fully amortized. This is why, after resuming amortization / increasing amortization rates for fixed assets that had been previously treated with a straight-line method only the same method can be applied. The rate of straight-line amortization previously decreased can be increased up to the maximum level defined in Specification. However the legislator predicted limitation of the moment, in which resuming the depreciation or increasing to increase, by means of a coefficient, amortization rate decreased (even down to 0% level) for a amortization rates can take place. Increased amortization rates can be applied for the first month of the following tax year after the year, in which a decision to increase them was made. Moreover, in order given asset, taxpayer shall firstly make a decision to increase this rate up the maximum possible level resulting from Specification, and then make a decision to increase the rate by means of an additional coefficient. It results from the fact that in order to apply coefficient to increase amortization rate, the amortization rate shall be highest possible for a given fixed asset resulting from Specification. Amortization of intangible assets According to the provisions of CIT Act, taxpayers define amortization rates for given intangible assets for the whole period of amortization before first amortization deduction is made. The above regulation indicates that for a given intangible asset, for the whole period of amortization, taxpayer defines one amortization rate. This rate cannot be decreased or increased in the course of making amortization deductions. However, in relation to intangible assets that taxpayer is planning to introduce into fixed assets account it is possible to plan amortization procedure in a way most convenient for the taxpayer because CIT Act points (directly or indirectly) the maximum amortization rate for given intangible assets. Registering decision on changing amortization rates Taxpayer shall keep records on making the decision concerning changes in amortization rates (decreasing or increasing). Regulations do not define how the decision shall be registered there are no legal requirements as far as the form of such a record is concerned. In our opinion any form of recording decision on changing amortization rates resolution, disposition, etc., is the right form. Only entitled persons shall make such a decision. For decision on changing amortization rates it is not required to point the reasons for such a change. To sum up it should be stated that possibility of making a decision concerning change of amortization rates in the course of the fixed assets depreciation or for applying reduced amortization rates for new fixed assets is a tool of the influence on results achieved by the taxpayer predicted in the CIT Act. It can bring notable benefits in tax settlements in case of competent using this possibility by taxpayers.

17 Tax KPMG Forum 17 Monika Jasińska Specialist in Tax Department in KPMG in Katowice KPMG in Poland Joined the KPMG team in May Participated in projects connected to the functioning of companies from the automotive branch in special economic zones Monika participated in projects connected to the obtainment of zone permissions as well as within zone reviews. The so far tasks executed by Ms. Jasińska also encompassed participation within the review of CIT, CAT and PCC taxes. Author of various publications in tax press Michał Lejman Manager in Tax Department in KPMG in Katowice KPMG in Poland Licensed Tax Advisor. Michał Lejman works within the field of tax advisory since Michał mainly specializes in legal entity income tax issues (including international taxes) as well as in the field of added value tax. Currently Michał advises mostly entities from the automotive and mining industries. He participated in numerous tax settlement review projects. The scope of his specialisation amongst other encompasses: Current and ongoing advisory, including the preparation of tax opinions, documentation of transfer prices, benchmarking as well as conveyance of tax reviews, Representation of clients interests in disputes with tax organs (fiscal controls and procedures in front of administration courts), Advisory within the scope of planning of tax transactions, tax restructuring as well as mergers and takeovers, Project design as well as implementation of management personnel remuneration system restructuring plans with the application of the provisions of authorship law as well as industrial property rights. 1 Journal of Laws No. 74 item 397 with later amendments 2 Załącznik 1 do Ustawy CIT Wykaz Rocznych Stawek Amortyzacyjnych

18 18 KPMG Forum Corporate Finance Valuations prepared by Polish stock brokers vs. best practices of mature markets Introduction Clarity, simplicity as well as objectiveness always constitute the valuable attributes of any valuation. In the case of stock brokers the aforementioned values gain additional meaning, since their recipients and clients are frequently constituted by individual investors, who do not prepare business valuations to make a living. Nevertheless, the strive towards the clarity may lead to generation of a number of simplifications within the prepared valuations, which in turn contributes to the increase of the probability of error. The aim of this article is to analyse the coherence of methodologies of valuation applied by stock brokers, contained in their analytical reports, with the best practices of mature markets in this scope. Methodology 20 recommendations of 10 Polish stock brokers have been collected for the needs of our examination followed by their analysis within the context of adopted methodology and approach. Next, all of the received results have been compared with best practices of mature markets, choosing the American market, the reference point for which was constituted by the opinions of Delaware Court as the determinant of the best practices from the field of methodology of business valuations. Delaware Court Delaware is one of the smallest states of the United States of America with the population below 1 million. Nevertheless, considering beneficial corporate law of the state, a number of large companies have been registering within the state for many years now. Considering the above, Delaware Court issues rulings in a great number of cases associated with mergers and acquisitions, especially resolving disputes arisen in connection with the valuation of companies. Years of experience result in the fact that Delaware Court seems to be one of the Area Valuation approach Methods to estimate the cost of equity Capital structure Residual value Analysed issues most respected institutions within the field of business valuations worldwide. KPMG s analysis We have analysed key areas associated with the valuations, which are presented in the table below, and compared the results with the best American practices in this field. Valuation approach 7 out of 10 analysed stock brokers adopted both market and income approach and attributed each the equal share of 50/50 importance. Based upon the provisions of best practices, a business valuation should be prepared Weights of income and market methods Method applied Risk free rate Equity risk premium Beta Specific risk premium Methods to select capital structure Methods of residual value estimation Residual growth rate

19 Corporate Finance KPMG Forum 19 with the application of at least two methods, yet usually the greater importance is assigned to the income approach. Cost of equity Each one of the 10 stock brokers applied the capital asset pricing model (CAPM Model) in the process of estimation the cost of equity. In accordance with the best applicable American standards the aforementioned approach is completely acceptable. The CAPM Model requires the estimation of the key parameters, the value of which may significantly influence the valuation result: risk free rate; equity risk premium; beta; specific risk premium. The comparison of the methodology applied for the estimation of the components of the cost of equity has been presented in the table below. The aforementioned comparison proves that the differences in the applied methodology concern the estimation of beta as well as the specific risk premium. In 19 out of 20 valuations under our examination, the beta coefficient was determined based upon the expert method, i.e. subjective assessment made by the appraiser. Additionally, in 9 out of 20 valuations, beta at the level of 1.0 was adopted. Best practices assume the beta to be precisely determined based upon the analysis of the comparable companies. Yet, in certain cases the direct adoption of the company s beta is also allowed. None of the 10 examined stock brokers decided to increase the cost of equity with the specific risk premium. In particular, none of the valuations included size premium. In accordance with the best American practices, the size Best American practices prefer to adopt the residual growth rate higher than the forecasted CPI growth rate. Picture 1. Comparison of the methodology of estimation of the cost of equity The cost of equity (CAPM Model) Risk free rate Equity risk premium Beta Specific risk premium Parameter Best American standards Stock broker standards in Poland Risk free rate Equity risk premium Beta Specific risk premium Yield of long term bonds 10 year bonds are a standard Historical premium is based upon empirical results of the longest possible time horizon The acceptable level ranges from 5.0% to 5.5% Usually based upon betas of comparable companies Sometimes the beta of a company is acceptable (the so-called raw beta ) Premium for the company size is usually taken into consideration in the valuation 10 out of 10 stock brokers adopted the yield of long term bonds 10 year bonds were most frequently applied Premium adopted with the application of the expert approach 9 out of 10 stock brokers adopted the premium at the level of 5.0% - 5.5% In 19 out of 20 valuations beta was chosen with the application of the expert method In 9 out of 20 valuations beta at the level of 1.0 was adopted None of the 10 stock brokers took into consideration the specific risk premium / Source: KPMG s analysis

20 20 KPMG Forum Corporate Finance premium should be generally taken into consideration in the valuation. The choice of capital structure All stock brokers encompassed in the KPMG s analysis adopted the projected capital structure of a company based on its current structure as well as on the future demand for debt capital. This approach, in accordance with best American standards, is acceptable for the purpose of minority stakes valuation, however it does not comply with the requirements of valuation for the financial reporting purposes, in such cases the capital structure of comparable companies needs to be considered, i.e. market participant approach. Estimation of the residual value To calculate the residual value all of the analysed stock brokers applied the Gordon model. At the same time this approach is most preferred, according to the best American valuation standards. Stock brokers under examination usually assumed that the residual growth rate is equal to or lower than the projected level of inflation. In only 5% of analysed valuations the growth rate was higher than the forecasted growth of the Consumer Price Index (CPI). Additionally, in 7 out of 20 valuations the growth rate was lower than the inflation forecast. Best American practices prefer to adopt the residual growth rate higher than the forecasted CPI growth rate. It is argued that a company experiencing growth rate at the inflation level or lower would, in the long run, discontinue its business activity. The preferred growth rate is usually higher than inflation by 1-2 percentage points. At the same time, it should not exceed the rate of nominal GDP growth of a given economy. The influence of the change of the residual growth rate upon the final valuation varies for particular cases. Adoption of higher growth rate shall result in increasing the level of expected investments into fixed or current assets. Summary In the majority of aspects the methodology applied by stock brokers is coherent with best practices of mature markets valuation, however there are several significant differences in comparison with best practices, which may to a significant extent interfere with the valuation result. Unification of the approach would above all require: putting greater emphasis on the income approach by attributing higher weight in the valuation to this approach rather than to the market approach; discontinuing the application of the expert method while estimating beta along with its careful determination based upon the analysis of comparable companies; taking into consideration the company size premium in the calculation of the cost of equity; careful and thorough analysis of the residual growth rate, which could result Picture 2. Residual growth rate and projected CPI growth rate Percentage of valuations 70% 60% 50% 40% 30% 20% 10% 0% 35% lower than projected inflation in growth exceeding the level of inflation by 1-2 percentage points. Considering all of the above, due care should be applied in the process of examination and drawing conclusions from valuations prepared by stock brokers, since considering frequent significant alterations within the scope of applied methodology, the attained results may show divergence from fair values received with the application of best practises of valuation in mature markets. Therefore, in the case of significant transactions we recommend to engage professionals with significant experience in business valuations, which will surely apply best practices and which shall be undoubtedly independent and objective in executed analyses. 60% equal to projected inflation 5% higher than projected inflation Source: KPMG s analysis