With more than 80 spinoff and split-up transactions having closed in 2010, reaching a combined valuation upwards of $45 billion, it's safe to say such transactions are back in vogue.

Over the past two years, billion-dollar spinoffs have been executed by well-known companies such as Coca-Cola Enterprises Inc., Northrop Grumman Corp., Motorola Inc., Fiat SpA and Bristol-Myers Squibb Co. The trend shows no sign of slowing down anytime soon; during the first five months of 2011, more than 100 spinoffs were announced or closed.

As companies execute these transactions, either the remaining or the spun-off entities may provide guarantees or indemnifications against potential adverse outcomes. Financial executives and dealmakers need to understand the rationale for putting such guarantees in place, the accounting requirements and how to address the common challenges in recording spinoff-related guarantees at fair value.

There are two ways in which guarantees and indemnifications arise in a spinoff. First, prior to and unrelated to the spinoff, a parent company may have provided guarantees of performance for a subsidiary (for example, a guarantee with respect to product warranties or subsidiary performance on debt or lease obligations). Post-separation, the remaining entity may wish to charge its former subsidiary an appropriate fee for continuing to provide this guarantee.

Second, new guarantees or indemnifications regarding contingencies may also be created as part of the spinoff. Indemnifications of contingencies may be included in the separation agreement to share the pain of potential future liabilities in a manner that is perceived to be "fair," to clearly allocate the liability and thus avoid future litigation, or to make the spun-out entity more attractive to investors.

Under current U.S. accounting guidance, once the remaining and spun-off entities are no longer under common control, the indemnifier typically recognizes the above-mentioned types of guarantees and indemnifications at fair value, if material. Valuation of spinoff guarantees and indemnifications may not be easy. Furthermore, analysis of uncertain outcomes often involves procuring information and assessments on sensitive topics, such as the outcome of pending litigation.

One way to address the valuation difficulties is to look for a pertinent market. For instance, if there is an insurance market relevant to the contingency, insurance quotes can serve as an input into the valuation, perhaps with adjustments to account for differences between the relevant and the quoted risk. Insurance company margins can also provide guidance as to the appropriate compensation for assuming risk. Or, in the case of a loan guarantee, one might look at default probabilities or credit default swaps associated with companies with a similar credit rating as that anticipated for the new entity.

However, indemnifications related to litigation, tax and other contingencies often do not have any analogues that are traded in the market, making it difficult to use market data as a basis for determining fair value. In such cases, it can be useful to examine historical experience.

Where neither market nor historical data exists, management assessments will be required. We generally recommend maximizing the use of observable inputs, decomposition of the assessment task into smaller pieces on which ­(ideally) expertise or historical information exists, application of debiasing procedures and validation via crosschecks. In addition, one must carefully consider the scenario in which the triggering event occurs, especially if it is a rare, large-magnitude event.

To address the reluctance to disclose sensitive information, companies often aggregate individual tax or litigation issues into buckets with similar risk profiles. Management can then make assessments for the entire bucket rather than for each individual issue. This strategy also simplifies the valuation exercise in the cases where an indemnification covers hundreds of issues, as may happen in the spinoff of a large entity.

Guarantees and indemnifications of contingencies are not issues that companies often think about in day-to-day operations. When such issues arise in the context of a spinoff, a best-practice approach is to develop a preliminary estimate of the value, before closing. We have found that a preseparation valuation not only supports financial planning, but also sheds light on whether to renegotiate pre-existing guarantees, and raises important issues with respect to the appropriate scope of any new indemnifications.

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Lynne Weber is a managing director and Gary Raichart is a vice president of the strategic value advisory practice at financial advisory and investment banking firm Duff & Phelps Corp.