Business valuation (BV) reports frequently include information presented in the form of financial statements. The reporting requirements for such financial statements have drawn increased attention as a result of the issuance of Statement on Standards for Accounting and Review Services No. 19 (SSARS 19), Compilation and Review Engagements.
When conforming the existing SSARSs Interpretations to SSARS 19, the Accounting and Review Services Committee decided to withdraw an interpretation related to financial information in BV reports. It has become evident, based on questions the AICPA has received, that the move sparked some confusion. While many practitioners thought that an exception had been removed, the truth is nothing changed.
The AICPA issued Statement on Standards for Valuation Services No. 1 (SSVS1), Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset (available at tinyurl.com/2uk4gt2), which was effective Jan. 1, 2008, to improve the consistency and quality for members performing engagements that estimate values. SSVS1 includes relevant guidance on valuation reporting and comprises the same fundamental provisions that were included in the withdrawn interpretation.
In October 2011, the AICPA’s Forensic and Valuation Services (FVS) Executive Committee published the following series of questions and answers (available at tinyurl.com/73l8utx; FVS Section member login required) on these practice issues to provide guidance to CPAs who perform valuation engagements and ultimately submit valuation reports to third parties.
Q: If the valuation analyst uses a subject company’s general ledger and prepares financial statements that will be presented as part of the BV report, does the valuation analyst or his or her firm have to comply with Statements on Standards for Accounting and Review Services (SSARSs), including the performance and reporting requirements for a compilation engagement with respect to those financial statements?
A: Yes. If the valuation analyst uses the subject company’s general ledger to prepare financial statements and presents such financial statements in the BV report, there is a requirement to compile those financial statements in accordance with SSARSs, including providing a compilation report.
Paragraph .01 of AR Section 80, Compilation of Financial Statements, states that the accountant is required to comply with the provisions of AR Section 80 whenever he or she submits financial statements to a client or to third parties. Paragraph .04 of AR Section 60, Framework for Performing and Reporting on Compilation and Review Engagements, defines submission of financial statements as “presenting to management financial statements that an accountant has prepared.”
Q: In the course of developing a business valuation in accordance with SSVS1, a valuation analyst may make certain normalization or control adjustments to the financial statements (audited, reviewed, compiled, or internally prepared) provided by the subject entity. Is the valuation analyst required to compile this adjusted financial information in accordance with SSARSs?
A: No. Normalization and control adjustments are considered pro forma adjustments. Paragraphs .03–.04 of AR Section 120, Compilation of Pro Forma Financial Information, state:
“The objective of pro forma financial information is to show what the significant effects on historical financial information might have been had a consummated or proposed transaction (or event) occurred at an earlier date. Pro forma financial information is commonly used to show the effects of transactions such as the following: business combinations, changes in capitalization, disposition of a significant portion of the business, change in the form of business organization or status as an autonomous entity, [or] proposed sale of securities and the application of the proceeds.”
“This objective is achieved primarily by applying pro forma adjustments to historical financial information … .”
Further, paragraph .01 of AR Section 120 states, “… By definition, presentations of pro forma financial information are not financial statements.”
The International Glossary of Business Valuation Terms (SSVS1, Appendix B) defines “normalized earnings” as “… economic benefits adjusted for nonrecurring, noneconomic, or other unusual items to eliminate anomalies and/or facilitate comparisons.”
The adjustments (whether normalization adjustments or control adjustments) the valuation analyst makes to the subject entity’s financial statements are typically designed to adjust for unusual items or to eliminate anomalies and facilitate comparisons. They are in the nature of pro forma adjustments, which result in presentations of financial information that, by definition, are not financial statements. There is no requirement to report on the adjusted financial information unless the valuation analyst or his or her firm has been separately engaged to do so. It would be beneficial if the adjusted financial information would be labeled as “pro forma financial information.”
If the valuation analyst receives internally prepared company financial statements and retypes them for side-by-side comparison in the valuation report, he or she is not required to compile those internally prepared company financial statements in accordance with SSARSs. See SSVS1, Appendix A, Assumption 2.
Q: If the information provided to the valuation analyst by the subject entity is tax return information and the valuation analyst makes adjustments to the tax return information, is the valuation analyst or his or her firm required to prepare a compilation report?
A: No. Tax return information, by definition, is not a financial statement. Therefore, adjustments to tax return information do not change its nature into that of a financial statement.
Adjustments to tax return information are also in the nature of pro forma adjustments. They are designed to eliminate anomalies or unusual items. The result is adjusted financial information on which there is no requirement for the valuation analyst to report.
If the valuation analyst receives historical tax returns and retypes the tax return information for side-by-side comparison in the valuation report, there is no requirement for him or her to report on this retyped tax return information. See SSVS1, Appendix A, Assumption 2.
For more information on SSVS1 and business valuation, visit the AICPA’s Forensic and Valuation Services Center at aicpa.org/FVS.