Forensic and Investigative Accounting Chapter 17 Business Valuations © 2011 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com

Valuation and Appraiser Accreditations Business appraisers have traditionally come from either a finance or accounting background. Chapter 17 Forensic and Investigative Accounting

Valuation and Appraiser Accreditations The following certifications are offered: Accredited Senior Appraiser (ASA) and Accredited Member (AM) awarded by the American Society of Appraisers (ASA). Certified Business Appraiser (CBA) awarded by the Institute of Business Appraisers (IBA). (continued on next slide) Chapter 17 Forensic and Investigative Accounting

Valuation and Appraiser Accreditations Certified Valuation Analyst (CVA) awarded by the National Association of Certified Valuation Analysts (NACVA). Accredited in Business Valuation (ABV) awarded by the American Institute of Certified Public Accountants (AICPA). Chartered Financial Analyst (CFA) awarded by the Association for Investment Management and Research (AIMR). Chapter 17 Forensic and Investigative Accounting

Engagement Agreements An engagement agreement is necessary in any valuation or client-related undertaking because it: Clearly sets forth the expectations of the business valuator and client. Reduces the chance for misunderstanding and, therefore, the risk of malpractice litigation and claims against the business valuator. Increases the likelihood of the valuator being paid, since it establishes a clear obligation on behalf of the client. (continued on next slide) Chapter 17 Forensic and Investigative Accounting

Engagement Agreements The following specifics need to be considered in drafting an engagement agreement: Identify the client. Specify the interest, date, purpose, and intended use of the valuation. Define the standard of value. (continued on next slide) Chapter 17 Forensic and Investigative Accounting

Engagement Agreements Assign responsibility for fees and costs. Price the engagement. Specify responsibility for real estate and other appraisal costs. Obtain a retainer. Protect against the use and misuse of forecasts by clients. Include indemnification language. Include other terms and conditions. Chapter 17 Forensic and Investigative Accounting

Purposes for Obtaining Business Valuations Tax purposes. Divorce distributions. Liquidations. Employee stock ownership plans (ESOPs). Lost profit analyses. Mergers and acquisitions. Minority shareholder distributions. Buy-sell agreements. Bankruptcies. Recapitalizations. Management buyouts. Allocations of purchase price. Chapter 17 Forensic and Investigative Accounting

General Types of Valuations Asset-based approach—This type of valuation is used to value asset-intensive businesses such as retail and manufacturing. The focus is on what the equipment and real estate are worth. Income approach—This type of valuation is useful for service companies. The focus is on how much money a buyer can make from the business. (continued on next slide) Chapter 17 Forensic and Investigative Accounting

General Types of Valuations Market approach—This type of valuation looks at what the market is paying for similar businesses and is used to value many different types of businesses. The focus is on the marketplace: what others have paid for similar companies. Chapter 17 Forensic and Investigative Accounting

Forensic and Investigative Accounting Standards of Value Fair market value. Fair value—100 percent controlling interest value. Fair value—minority interest and marketable value. Fair value—minority interest but nonmarketable. Investment value. Intrinsic value. Chapter 17 Forensic and Investigative Accounting

Forensic and Investigative Accounting Income Approach Capitalization of income method. Discounted future income method. Discounted future cash flow method. Capitalization of excess earnings method. Chapter 17 Forensic and Investigative Accounting

Forensic and Investigative Accounting Market Approach Guideline (public company) method. Market data method. Past transactions method. Chapter 17 Forensic and Investigative Accounting

Forensic and Investigative Accounting Cost Approach Book value (not really a valuation method). Adjusted book value (adjusted net asset value). Chapter 17 Forensic and Investigative Accounting

Gathering Initial Information Goals of pre-engagement phone contact include: Develop trust and rapport. Gain a brief understanding of the business. Determine who will be responsible for gathering information. Explain the valuation process and timing. Determine methods of corresponding with the client. Chapter 17 Forensic and Investigative Accounting

Discerning What Data Is Required Request forecasts of future financial results. Review articles on industry-related valuation issues. Request client information prior to company interviews. Chapter 17 Forensic and Investigative Accounting

Spreading Financial Statements Financial spreadsheet reports include: Actual and common-sized income statements. Actual and common-sized balance sheets. Financial statement ratios. Trend statements. Chapter 17 Forensic and Investigative Accounting

Analyzing Financial Statements for Trends and Risks The purpose of analyzing a company’s historic financial statements is to provide information about these factors that are crucial in the preparation of a valid valuation: Trends and what they say about the possible future. How well or how poorly a company performs compared to industry peers. Key elements of company strategy. Chapter 17 Forensic and Investigative Accounting

Income Statement Profitability Analysis Income statement profitability analysis helps valuators determine the following: Judgments about the historic performance of the company and the variability of results. Results against which to assess management’s strengths and weaknesses, and how this would impact an investor’s perception of the shares as an investment, and their associated risk. (continued on next slide) Chapter 17 Forensic and Investigative Accounting

Income Statement Profitability Analysis An objective basis for comparing a company’s performance relative to its industry peers. Insight into a company’s economics and how the business achieves its net profit on a given level of revenues. Clues concerning the internal and external forces that affect the business, and what this suggests about risk, future threats, and opportunities. Chapter 17 Forensic and Investigative Accounting

Income Statement Analysis Revenues Past trends. Growth rates. Variability in individual annual results. Overall observed results. Identification of the appropriate questions. Gross profits Components of goods sold. Calculation of goods sold. (continued on next slide) Chapter 17 Forensic and Investigative Accounting

Income Statement Analysis Operating expenses. Operating profits. Other income and expense. Pretax profitability. Chapter 17 Forensic and Investigative Accounting

Business Valuation Standards Uniform Standards or Professional Appraisal Practice (USPAP) from The Appraisal Foundation Code of Professional Conduct from the American Institute of Certified Public Accountants (AICPA) Statement of Financial Accounting Standards No. 157 from the Financial Accounting Standards Board (FASB) Chapter 17 Forensic and Investigative Accounting

Features of the Standards Independence. Fee not contingent on appraised value. Limiting conditions. Professionals participating in the assignment. Information sources used. Report content. Data collection and analysis. Methodology. Reconciliation of findings of value. Adjustments to valuation findings. Conclusion of value. Chapter 17 Forensic and Investigative Accounting

Forensic and Investigative Accounting Report Content Purpose and scope of the assignment. Standard of value used. Identification of the specific interest being valued. Specific valuation date used. Relevant state law governing the entity. Scope of the valuation report. Chapter 17 Forensic and Investigative Accounting

Organization of the Report Front pages Cover sheet (with company name and valuation date) Transmittal letter Table of contents Introduction Company information Financial condition Valuation methodology (continued on next slide) Chapter 17 Forensic and Investigative Accounting

Organization of the Report Valuation conclusion Exhibits Limiting conditions Definitions of valuation terms Qualifications of the valuation professionals who worked on the report Common size balance sheets of the company Common size income statements of the company Ratio analysis of the company Chapter 17 Forensic and Investigative Accounting

Standards of Valuation The are a number of standards that may be applied to valuation engagements The Uniform Standards of Professional Appraisal Practice (USPAP) Codifies many common sense standards of professional appraisers American Institute of Certified Public Accountants (AICPA) Issues more general standards of valuation as it relates to the braod activities of CPAs Chapter 17 Forensic and Investigative Accounting

Statement of Financial Accounting Standards No. 157 This standard address the issue of “fair Value Measurements” It defines Fair Value Establishes a framework for measuring value in in GAAP Relates fair value to publications issued by the FASB Concepts Statements No. 2, No. 6, and No. 7 Chapter 17 Forensic and Investigative Accounting

Guidelines for Preparing to Testify Review and update your resume. Know and understand the facts of the case. Anticipate and prepare answers for expected difficult questions at deposition and cross examination. Understand all information and calculations in the expert report. Chapter 17 Forensic and Investigative Accounting 30

Guidelines for Preparing to Testify Carefully prepare for deposition testimony. Be certain there are no conflicts of interest. The expert must testify so that court can clearly understand the issues in the expert’s testimony. Chapter 17 Forensic and Investigative Accounting 31