Professional Guidance in Business Valuation: Applying SSVS1

PAs perform valuation services for numerous purposes, including transactions, financings, taxation planning and compliance, intergenerational wealth transfer, ownership transition, financial accounting, bankruptcy, management information, and planning and litigation support. In June, the AICPA Consulting Services Executive Committee issued the Institute’s first professional guidance to members who provide valuation services, Statement on Standards for Valuation Services (SSVS) no. 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset . This article summarizes the content and intent of the statement related to valuation engagement considerations, valuation development guidance and valuation reporting requirements. It also outlines the practical application (and practical implications) of the statement.

The statement, which is effective for valuation engagements accepted after Jan. 1, 2008, is expected to:

1. Provide members with professional guidance related to
   “best practices” in valuation services.
   
2. Allow members who provide tax-related valuations to comply
   with “generally accepted appraisal standards” as required
   by the Pension Protection Act of 2006.
   
3. Improve the quality and consistency of valuation practices.
   
4. Enhance the transparency and replicability of valuation
   analyses and reports.
   
5. Encourage the standardization of valuation analysis data
   gathering and valuation report content and formats.
   
6. Recognize what are (and are not) generally accepted valuation
   approaches and methods.
   
7. Enhance the reliance on the valuation process by clients,
   judicial finders of fact, the investment community and others.
   
8. Encourage a clear, documented understanding between
   members and clients as to (a) the level of valuation service
   and (b) the type of valuation report.

Exhibit 1 presents the “Top 10” expected benefits.

WHEN THE STATEMENT DOES (AND DOES NOT) APPLY
The statement applies to any engagement to estimate the value of a business, business ownership interest, security or intangible asset (collectively the “subject interest”).

It does not apply in the following situations:

 n The value of the subject interest is provided to the member by the client or a third party and the member (1) does not apply valuation approaches and methods and (2) does not report on the value of the subject interest.

 n The member calculates value as part of an audit or review engagement.

 n Internal use assignments from employers to employee members who are not in the practice of public accounting.

 n Engagements that are exclusively for the purpose of determining economic damages (unless such determination is used to estimate the value of a subject interest).

 n Mechanical computations that do not rise to the level of an engagement to estimate value (that is, where the member does not apply valuation approaches and methods or use professional judgment).

 n Where it is not practical or reasonable for the member to obtain or use relevant information and the member is unable to apply valuation approaches and methods.

 n A jurisdictional exemption, when the statement differs from published governmental, judicial or accounting authority.

ENGAGEMENT CONSIDERATIONS
In determining professional competence to perform a potential valuation engagement, the statement requires the member to consider:

1. The subject entity and subject industry.
2. The subject interest.
3. The valuation date.
4. The scope of the valuation engagement, including:
   The purpose of the engagement.
   Any assumptions and limiting conditions.
   The applicable standard of value.
   The type of report to be issued.
   The intended use and users.
   Any restrictions on the use of the report.
5. Any governmental regulations or other professional standards that apply to the engagement.

Before accepting the engagement, the valuation analyst should establish an understanding with the client, either oral (with workpaper documentation) or written. Any scope restrictions on the valuation analyst’s work or on data availability should be disclosed in the valuation report. The valuation analyst may rely on third-party specialists (such as real estate or equipment appraisers) in the valuation. The statement requires the valuation analyst to disclose the level of responsibility of the work of any third-party specialists in the assumptions and limiting conditions.

As with all professional services, the valuation analyst must comply with the AICPA Code of Professional Conduct Rule 201A regarding professional competence. The Code of Professional Conduct requires objectivity in all professional services. In addition, with regard to valuation services for attest clients, the member must comply with Rule 101 of the Code of Professional Conduct related to independence.

Exhibit 1		Expected Benefits Associated With the Statement
	Expected Client Benefits Clients can reach a clear understanding with the valuation analyst regarding the level of valuation service to be performed. The statement provides for well-defined alternative types of valuation development analyses. Clients can reach a clear understanding with the valuation analyst regarding the type of valuation report (that is, engagement deliverable). The statement provides for several well-defined types of valuation reports. As it is described in the valuation report, the valuation analysis should be replicable. That is, the client (or other report reader) should be able to (1) replicate the valuation approaches, methods and procedures and (2) duplicate the value conclusion. There should be transparency in the valuation analysis and in the valuation report. This transparency should increase the client’s confidence in the valuation process and in the value conclusion. Clients should benefit from both increased consistency and comparability between different analysts’ valuation reports. Expected Member Benefits The statement provides professional guidance as to generally accepted “best practices” within the valuation community. In defending the valuation work during a contrarian challenge (for example, by the IRS, a regulatory agency, an opposing expert witness or a litigation cross-examination), the member will have the assurance that his or her analysis and report are prepared in accordance with the statement. Members may rely on the statement for professional guidance with regard to what are (and are not) considered generally accepted valuation approaches. Members may rely on the statement for professional guidance with regard to the type of documents and documentation (both financial and nonfinancial) that should be considered in the valuation process. The Pension Protection Act of 2006 requires members who perform certain tax-related valuations to comply with “generally accepted appraisal standards.” Compliance with the statement allows the member to meet the IRS requirements.

TWO TYPES OF ENGAGEMENTS
The statement describes two types of engagements: a valuation engagement and a calculation engagement.

In a valuation engagement, the valuation analyst is free to apply the valuation approaches and methods he or she deems appropriate. The results are expressed as a conclusion of value —either as a single amount or as a range of values.

In a calculation engagement, the valuation analyst and the client agree on the valuation approaches and methods to use and the extent of procedures the analyst will perform to calculate the value of the subject interest. The results are expressed as a calculated value—either as a single amount or as a range of values. A calculation engagement does not include all of the procedures of a full valuation engagement, and the resulting value may be different.

VALUATION ENGAGEMENTS
The minimum information that a member needs to analyze in a valuation engagement will depend on:

1. The nature of the subject interest.
2. The scope of the valuation engagement.
3. The valuation date.
4. The intended use of the valuation.
5. The applicable standard of value.
6. The applicable premise of value.
7. The assumptions and limiting conditions.
8. Any applicable government regulations or other professional standards.

Professional guidance is provided on the types of financial information and nonfinancial information that the valuation analyst should consider in the engagement.

The valuation analyst should obtain and analyze ownership information to:

1. Determine the type of ownership interest and whether it is a controlling, majority or minority interest.
2. Analyze the ownership interests of other owners and the impact of that ownership on the value of the subject interest.
3. Understand the classes of ownership interest and the rights assigned to each.
4. Understand the rights included in—or excluded from— each intangible asset.

When concluding on the value in a valuation engagement, a member should:

1. Correlate, reconcile and assess the reliability of the results from the different valuation approaches and methods.
2. Determine whether the value conclusion should be based on one valuation method or on a combination of valuation methods.

A subsequent event is defined as an event that occurs subsequent to the valuation date but prior to issuance of the valuation report. The valuation analyst should distinguish between two types of subsequent events. In the first type of subsequent event, the analyst should consider in the valuation analysis only those events that are indicative of conditions that were known or knowable on the valuation date. In the second type of subsequent event, the analyst should not consider in the valuation analysis (but the analyst may disclose in the report) a subsequent event that is not indicative of conditions that were known or knowable on the valuation date.

CALCULATION ENGAGEMENTS
The analyst’s calculation engagement considerations should include:

1. The identity of the client.
2. The identity of the subject interest.
3. Any ownership control and/or marketability elements of the subject interest.
4. The purpose and intended use of the calculated value.
5. The intended users of the report and the limitations on the report use.
6. The valuation date.
7. The applicable standard of value.
8. The applicable premise of value.
9. The sources of information used.
10. Any valuation approaches and methods agreed on with the client.
11. The disclosure of any subsequent events.

VALUATION APPROACHES AND METHODS
The valuation analyst should use all valuation approaches and methods that are appropriate to the engagement and consider all three generally accepted valuation approaches. For the valuation of a business, business ownership interest or security, the member should consider:

1. The income approach.
2. The market approach.
3. The asset-based approach.

For the valuation of an intangible asset, the member should consider:

1. The income approach.
2. The market approach.
3. The cost approach.

The statement says a “rule of thumb” is not an appropriate valuation method. However, a rule of thumb can be used as a reasonableness check in a valuation analysis but should not be the only method used to value the subject interest.

In a business or security valuation, the valuation analyst should consider whether valuation adjustments should be made to the pre-adjustment value indication, including:

1. A discount for lack of marketability,
2. A discount for lack of ownership control, or
3. A premium for ownership control.

The valuation analyst should also consider the existence of non-operating assets, non-operating liabilities, and any excess/deficient operating assets. In addition, the valuation analyst should consider the impact of the lack of ownership control on the value of such assets/liabilities.

MULTIPLE TYPES OF VALUATION REPORTS
A valuation report is a communication to the client containing the value conclusion or the calculated value of the subject interest. Valuation reports may be either written or oral. There is an exemption from the reporting provisions in the statement for certain controversy proceedings.

For a valuation engagement resulting in a conclusion of value, there are two types of reports:

1. A detailed report, which provides sufficient information to permit the report reader to understand the data, reasoning and analyses underlying the value conclusion. The statement describes the 14 disclosures that should be included in a detailed report.
    
2. A summary report presenting information that would otherwise be provided in a detailed report. The statement describes the 22 disclosures that should be included in a summary report.

For a calculation engagement resulting in a calculated value, there is only one type of report: a calculation report. Of course, the report should state that it is a calculation report. It should identify:

1. Hypothetical conditions used.
2. Any jurisdictional exception.
3. Assumptions and limiting conditions.
4. A description of any specialist’s work relied on and the level of responsibility the valuation analyst assumes for the specialist’s work.
5. A disclosure of any subsequent events.

In addition, the calculation report should summarize the calculated value. The statement describes the 11 disclosures that should be included in a calculation report.

Oral reports may be used in either a valuation engagement or a calculation engagement. An oral report should include all information necessary to relate the scope, assumptions, limitations and results of the engagement. It should be conducted in such a manner as to limit any misunderstanding between the valuation analyst and the oral report recipient. The valuation analyst should document the substance of the oral report in the engagement workpapers.

STATEMENT APPENDICES
The statement includes four appendices:

1) Appendix A: an illustrative list of assumptions and limiting
    conditions for a business valuation.
2) Appendix B: an international glossary of business valuation
    terms.
3) Appendix C: a glossary of statement-specific valuation terms.
4) SSVS1, Interpretation no. 1, “Scope of Applicable Services.”