On June 21, 2007, the American Institute of Certified Public Accountants, “AICPA”, released the Statement on Standards for Valuation Services No. 1 (SSVS No. 1) – Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset (“Standards”). These standards are effective for all valuation engagements accepted on or after January 1, 2008. The purpose of these Standards is to improve the consistency and quality of practice among CPAs that perform valuation services. The Standards were developed because Congress, government agencies and regulators have recently focused their attention on valuation issues, as well as the increasing demand for valuation services over the past 20 years.
The Standards specify two types of engagements: valuation engagements and calculation engagements. Valuation engagements would typically be the one required in a divorce matter.
In determining whether the valuation engagement can reasonably be expected to be completed with professional competence, the standards require that the valuation analyst consider, at a minimum, the following: (a) the subject entity and its industry; (b) the subject interest; (c) the valuation date; (d) the scope of the valuation engagement (including the purpose of the engagement, any assumptions or limiting conditions that are expected to apply to the valuation, the applicable standard of value (i.e. fair market value or fair value) and premise of value (i.e. going concern), the type of report to be issued, the intended use and users and the restrictions on the use of the report); and (e) any governmental regulations or other professional standards that apply to the entity to be valued or to the valuation engagement.
Additionally, in understanding the nature and the risks of the valuation services to be provided, the standards require that the expert should consider: (a) the proposed terms of the engagement; (b) the identity of the client; (c) the nature of the ownership interest, including control and marketability issues; (d) the procedural requirements of the valuation and whether they will be limited by either the client or circumstances beyond the client’s control; (e) the use and limitations of the report and the conclusion or calculated value; and (f) any obligation to update the valuation.
Under the Standards, the accountant is permitted to rely on the work of a third party specialist, such as a real estate or equipment appraiser and has the option of appending the specialist’s report within their valuation report.
In performing a valuation engagement, the standards require the CPA to analyze the subject interest (considering many of the factors previously addressed); consider and apply appropriate valuation approaches and methods and prepare and maintain appropriate documentation. The analysis of the subject interest should include financial information for the relevant period such as historical and prospective financial information, comparative summaries of financial statements, comparative common size financial statements, tax returns, information on owners compensation and key man life insurance, advantageous or disadvantageous contracts, contingent or off balance sheet assets or liabilities and information regarding prior sales of the entity. Additionally, non-financial information must be considered such as the nature, background and history of the entity, the facilities, the organizational structure, the management team, classes of equity ownership interests and the rights attached thereto, products or services, or both, the economic environment, the geographic markets, the industry markets, key customers and supplies, competition, business risks, strategy and future plans and the governmental and regulatory environment.
In performing the valuation, consistent with past practices for a typical valuation, the accountant should consider the three most common valuation approaches: the income approach, the asset approach and the market approach. While using the capitalization of benefits method (an income approach), the accountant should consider normalizing adjustments, non-recurring revenue and expenses, taxes, capital structure and financing costs, appropriate capital investments, non-cash items, qualitative judgments for risks used to compute discount and capitalization rates and expected changes in future benefits. When performing a discounted future benefits analysis (also an income approach), the accountant must consider forecast/projection assumptions, forecast/projected earnings or cash flows and the terminal value. When using the asset approach, the assets and liabilities must be identified, the assets and liabilities must be valued and the liquidation costs must be considered. In using the market approach (i.e. looking for comparable sales), the accountant must consider qualitative and quantitative comparisons, whether the data reflects arms-length transactions and prices and the dates and relevance of the market data.
The accountants are also required to consider valuation adjustments such as discounts (lack of marketability or lack of control) and premiums. Though consideration of these adjustments is seemingly required, it will be interesting to see how this is applied in New Jersey since discounts are disfavored in matrimonial valuations.
Subsequent events that were not known or knowable as of the valuation date are not to be considered. This is significant as there was considerable debate in the valuation community about the appropriateness of using subsequent events.
The Standards, in large part, comprehensively state what the more skilled accountants have been doing for some time. However, another benefit of the Standards, aside from uniformity, is the creation of a road map to use both to be sure that your valuation expert’s report is as unassailable as possible, and to provide fodder for cross-examination of the adverse expert.