New Business Valuation Standards for Accountants

Description of the New AICPA Standards

SSVS 1 comprises over 75 pages and can be downloaded at www.aicpa.org. The last section of the publication (starting on page 55) gives examples and illustrations of what is and what is not a valuation engagement, with particular emphasis on litigation and tax-related assignments. Keep in mind that these standards were not written solely for matrimonial engagements, even though those are the most common type of valuation assignment for many accountants. This new statement also covers business valuation in fair value reporting, estate and gift compliance, merger/acquisition/transactional matters, bankruptcy, dissenting shareholder disputes, ESOPs, and stock redemption reporting, among others.

Emphasis is given to professional competence to undertake the assignment, objectivity, independence, and treatment of conflicts of interest (paragraphs 11 through 20). Developmental principles (paragraphs 21 through 46) describe how a 'valuation' or a lesser 'calculation' should be performed by citing approaches and methods of analysis. Reporting principles (paragraphs 47 through 78) suggest the topics and content in a variety of reporting options, although no specific format or rules are mandated. There is an exemption from the SSVS 1 reporting provisions (paragraph 50) for certain controversy proceedings, whether the matter proceeds to trial or settles before trial. Consequently, since matrimonial dissolutions are litigious by nature, SSVS 1 presupposes no reporting requirements at all, instead allowing 'the client' (or, the client's attorney) to decide which reporting method should be used.

SSVS 1 applies to an accountant's (or analyst's assignment to estimate value by: 1) applying valuation approaches and methods; and, 2) using professional judgment as an essential component of estimating value. SSVS 1 applies in valuing stock that is not publicly traded, and/or requires a judgmental discount for blockage,
lack of control, or lack of marketability (illiquidity). SSVS 1 does not apply when computing economic damages, or doing mechanical calculations of value (for example, when using actuarial tables or computing per-share price of minor blocks of publicly traded stock when price is readily ascertainable). Litigation matters, such as marital dissolutions, require business valuation services. Hence, for attorneys requiring an expert to opine on the value of closely held stock as an asset in a marital dissolution, the developmental principles of SSVS 1 apply.

Issues of Work Quality

SSVS 1 requires the valuation analyst to follow good business practices, most of which are common to well-seasoned accountants undertaking marital valuations. The accountant should discuss with the attorney the scope and requirements of the engagement, considering the client's needs, as well as the requirements of any third party, such as judicial authorities. An engagement letter should be signed by either the attorney or the client. Detailed analytical work is expected, with creation of a work-paper file and a suitable report.

The facts to be considered in the assignment are limited to what is known or knowable as of the date of value, although subsequent material events occurring after the date of value may be noted in the report. SSVS 1 defines subsequent events as events that were NOT known or knowable at the valuation date. Subsequent events should not influence the results of a valuation. This is an important concept with regard to marital dissolution, as a case may be open for several months. The determination of date of value is a legal issue, not an analyst's choice.

These procedures are really nothing new. What is new, however, are alternatives as to the type of work and the form of reports.

Concluding a Value or Perform- ing a Calculation? SSVS 1 allows the practitioner to perform an analysis implying either 'a conclusion of value' or a 'calculation of value.' Know the difference! Although the words 'appraisal' and 'opinion' are not treated in these new standards, business valuation experts hired in matrimonial matters are typically expected to provide an opinion of equity asset value for dissolution purposes, similar to appraisers of real property or personal property.

The Valuation Engagement calls for the valuation analyst to estimate the value of the subject interest following the development section of the Statement (paragraphs 23 through 45), which is a good treatment of generally accepted appraisal practices. The accountant/analyst is free to apply the appropriate valuation approaches, methods and procedures with judgment to interpret market evidence and salient facts surrounding the subject being analyzed. The opinion is expressed as a 'conclusion of value' ' either as a single amount or a range of values. The analyst should correlate, reconcile, and assess the reliability of the results from different valuation approaches and methods, and be able to discuss how the conclusion was developed based on one method or on a combination of methods. Valuation engagement documentation may include details on:

• Information gathered and analyzed;
• Any assumptions and limiting conditions;
• Any restrictions on the scope of work or the availability of data;
• The basis for any valuation assumptions;
• Valuation approaches and methods used;
• Any subsequent events considered; and
• How any 'rule of thumb' was considered.

The Calculation Engagement, on the other hand, limits the freedom of the appraiser and may not be suitable for a formal unrestricted opinion of value. The valuation analyst and client agree on: 1) the valuation approaches and methods to use; and 2) the extent of procedures to perform. This understanding with the client can be oral (with work paper documentation) or in written correspondence. Scope restrictions on the valuation analyst's work or on data availability should be disclosed in the calculation report. Results are expressed as a 'calculated value' ' either as a single amount or a range of values. In a calculation engagement, you may see language in the report similar to the following:

In a calculation engagement, the valuation analyst and the client agree on the specific valuation approaches and valuation methods the valuation analyst will use, and the extent of valuation procedures the valuation analyst will perform to estimate the value of the subject interest. A calculation engagement does not include all of the procedures required in a valuation engagement, as that term is defined in SSVS 1. Had a valuation engagement been performed, the results might have been different.

Nonetheless, a calculation engagement is not a quick and simple procedure. Considerations (which should be disclosed and documented in the work paper file) include:

• Identity of the client;
• Identity of the subject interest;
• Ownership control and marketability elements;
• Purpose and intended use of the calculated value;
• Intended users of report and any limitations on the report use;
• The valuation date;
• Applicable standard of value;
• Applicable premise of value;
• The sources of information used;
• Valuation approaches and methods agreed on with client; and
• Any subsequent events.

Written or Oral Report? SSVS 1 allows the accountant/analyst to provide either a written report or an oral report of the results for either a 'conclusion of value' or a 'calculated value.' The more robust valuation engagement allows either a detailed or summary report; the less robust calculation assignment provides for a 'calculation report.' An oral report (suitable for either 'valuation' or 'calculation' engagements) should sufficiently convey scope, assumptions, limitations and results to preclude any misunderstandings between the accountant/analyst and the recipient of the report. The substance of any oral report previously communicated to the client should be documented in the work papers.

Discoverable documents in work files should accompany every oral report. The written detailed report (paragraphs 47 through 70) provides all sufficient information to permit report users to understand the data, reasoning, and analyses underlying the value conclusion. Clients, attorneys and other business valuation professionals should be able to: 1) replicate the data sources and the valuation approaches, methods and procedures; and 2) duplicate the construction of the value conclusion.

The written summary report (paragraphs 71 and 72) provides only an abridged or condensed form of the information that would be provided in a detailed report. Minimum disclosures in a summary report should include the following:

• Identity of the client;
• Purpose and intended use of the valuation;
• Identity of the subject entity;
• Description of the subject interest;
• Subject interest ownership characteristics and degree of marketability;
• Valuation date;
• Valuation report date;
• Type of report issued (i.e., a summary report);
• Applicable standard of value;
• Applicable premise of value;
• Sources of information used in the valuation;
• Any assumptions and limiting conditions;
• Any restrictions/limitations on the scope of work or the data availability;
• Any hypothetical conditions assumed;
• Description of any other specialist's work relied on and the level of responsibility the valuation analyst assumes for the specialist's work;
• Valuation approaches and methods used;
• Reconciliation of value estimates and conclusion of value;
• Disclosure of any subsequent events;
• Any jurisdictional exception;
• Representation of the valuation analyst; and
• Signature of valuation analyst or analyst's firm

The written calculation report (paragraphs 73 through 77) should identify that the work performed was a calculation, and summarize the calculated value, including:

• Identification of the subject interest;
• Identification of the calculation date;
• Valuation report date;
• Statement that the valuation analyst is not obligated to update the calculation;
• Description of the calculation procedures performed;
• Statement that calculation was performed in accordance with SSVS 1;
• Description of the subject interest characteristics, including characteristics of control and marketability;
• A statement that the estimated value is a calculated value;
• A general description of the calculation engagement;
• The calculated value; and
• Signature of the valuation analyst or the valuation analyst's firm

Thoughts for Your Practice

For assignments where the matrimonial attorney hires a valuation analyst after Jan. 1, 2008 subject to the new AICPA standards, expect a good deal of effort devoted to the assignment. A 'quick and simple' estimate of equity value in a closely held company may be much more difficult to find among professionals in accounting firms. The issue of whether or not your valuation analyst in a calculation engagement has offered an opinion of value suitable for litigation purposes in a dissolution setting is unsettling, and may be the focus of attack from opposing counsel when a less than full scope analysis (or 'procedures agreed to with the client') is offered in evidence. Oral reports (with discoverable work files) should be supported by sufficient detail in the work papers, and may pose unusual difficulty for the expert witness to ensure compliance and consistency with the newly expected detailed procedures.

Looking ahead, the most common type of appraisal service from accountants to matrimonial attorneys may be a valuation engagement with a summary report. On the other hand, the most dangerous type of service offered by accountants in the years ahead may be a calculation engagement with an oral report. Know what you get!

Unfortunately for clients, professional fees will probably rise. The numbers of accountants who choose to undertake matrimonial valuation work may also shrink, due to the implied level of sophistication and diligence that will be expected. Overall, the bar is raised among accountants who analyze value. Be prepared to expect more and expose those who don't provide it!

Robert C. Schlegel, a member of this newsletter's Board of Editors, is a Principal with Houlihan Valuation Advisors in Indianapolis, IN. Jason Thompson is a Partner in the Business Valuation/Litigation Services Group with Greenwalt Sponsel & Co., Inc., an Indianapolis CPA firm.

In June 2007, the American Institute of Certified Public Accountants (AICPA) approved new business valuation standards effective for assignments accepted after Jan. 1, 2008 for all member accountants. The AICPA's Statement on Standards for Valuation Services No. 1 (SSVS 1), 'Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset,' is a solid, well-reasoned set of principles on how to perform and report a valuation analysis. SSVS 1 complements other business valuation standards, such as the Uniform Standards of Professional Appraisal Practice (USPAP) and standards already in force by the American Society of Appraisers (ASA), Institute of Business Appraisers (IBA), and the National Association of Certified Valuation Analysts. (NACVA). These latter appraisal-oriented organizations have member numbers ranging from about 5,000 to 50,000, and include many accountants who regularly undertake valuation assignments for marital dissolution purposes.

The AICPA, however, with about 330,000 CPAs, is by far the largest organization with membership in every state. Previously, only AICPA members who were also members of one of the other organizations were required to adhere to the valuation standards of that other organization. The new AICPA standard will require all of its individual and firm members who are involved in business valuations to follow the newly issued standards. State Boards of Accountancy are likely to adopt the standards too, further obligating CPAs who may not be members of the AICPA.

Matrimonial attorneys need to understand the impact of these new AICPA requirements to ensure that their clients benefit from the higher quality of work now expected, and to demand adherence to these standards when exposing poor work done by the casual valuation analyst. Be prepared for increased fee demands by accountants because of the increased risk of malpractice. Alternatively, some accountants may decline valuation assignments they may have attempted in the past because of lack of education, qualifications, or an inability to do the quantity of analytical work mandated to opine 'a conclusion of value.' Oral reports may become more common, although work- paper files provided through discovery should still contain a rich source for evidentiary questions.

Description of the New AICPA Standards

SSVS 1 comprises over 75 pages and can be downloaded at www.aicpa.org. The last section of the publication (starting on page 55) gives examples and illustrations of what is and what is not a valuation engagement, with particular emphasis on litigation and tax-related assignments. Keep in mind that these standards were not written solely for matrimonial engagements, even though those are the most common type of valuation assignment for many accountants. This new statement also covers business valuation in fair value reporting, estate and gift compliance, merger/acquisition/transactional matters, bankruptcy, dissenting shareholder disputes, ESOPs, and stock redemption reporting, among others.

Emphasis is given to professional competence to undertake the assignment, objectivity, independence, and treatment of conflicts of interest (paragraphs 11 through 20). Developmental principles (paragraphs 21 through 46) describe how a 'valuation' or a lesser 'calculation' should be performed by citing approaches and methods of analysis. Reporting principles (paragraphs 47 through 78) suggest the topics and content in a variety of reporting options, although no specific format or rules are mandated. There is an exemption from the SSVS 1 reporting provisions (paragraph 50) for certain controversy proceedings, whether the matter proceeds to trial or settles before trial. Consequently, since matrimonial dissolutions are litigious by nature, SSVS 1 presupposes no reporting requirements at all, instead allowing 'the client' (or, the client's attorney) to decide which reporting method should be used.

SSVS 1 applies to an accountant's (or analyst's assignment to estimate value by: 1) applying valuation approaches and methods; and, 2) using professional judgment as an essential component of estimating value. SSVS 1 applies in valuing stock that is not publicly traded, and/or requires a judgmental discount for blockage,
lack of control, or lack of marketability (illiquidity). SSVS 1 does not apply when computing economic damages, or doing mechanical calculations of value (for example, when using actuarial tables or computing per-share price of minor blocks of publicly traded stock when price is readily ascertainable). Litigation matters, such as marital dissolutions, require business valuation services. Hence, for attorneys requiring an expert to opine on the value of closely held stock as an asset in a marital dissolution, the developmental principles of SSVS 1 apply.

Issues of Work Quality

SSVS 1 requires the valuation analyst to follow good business practices, most of which are common to well-seasoned accountants undertaking marital valuations. The accountant should discuss with the attorney the scope and requirements of the engagement, considering the client's needs, as well as the requirements of any third party, such as judicial authorities. An engagement letter should be signed by either the attorney or the client. Detailed analytical work is expected, with creation of a work-paper file and a suitable report.

The facts to be considered in the assignment are limited to what is known or knowable as of the date of value, although subsequent material events occurring after the date of value may be noted in the report. SSVS 1 defines subsequent events as events that were NOT known or knowable at the valuation date. Subsequent events should not influence the results of a valuation. This is an important concept with regard to marital dissolution, as a case may be open for several months. The determination of date of value is a legal issue, not an analyst's choice.

These procedures are really nothing new. What is new, however, are alternatives as to the type of work and the form of reports.

Concluding a Value or Perform- ing a Calculation? SSVS 1 allows the practitioner to perform an analysis implying either 'a conclusion of value' or a 'calculation of value.' Know the difference! Although the words 'appraisal' and 'opinion' are not treated in these new standards, business valuation experts hired in matrimonial matters are typically expected to provide an opinion of equity asset value for dissolution purposes, similar to appraisers of real property or personal property.

The Valuation Engagement calls for the valuation analyst to estimate the value of the subject interest following the development section of the Statement (paragraphs 23 through 45), which is a good treatment of generally accepted appraisal practices. The accountant/analyst is free to apply the appropriate valuation approaches, methods and procedures with judgment to interpret market evidence and salient facts surrounding the subject being analyzed. The opinion is expressed as a 'conclusion of value' ' either as a single amount or a range of values. The analyst should correlate, reconcile, and assess the reliability of the results from different valuation approaches and methods, and be able to discuss how the conclusion was developed based on one method or on a combination of methods. Valuation engagement documentation may include details on:

• Information gathered and analyzed;
• Any assumptions and limiting conditions;
• Any restrictions on the scope of work or the availability of data;
• The basis for any valuation assumptions;
• Valuation approaches and methods used;
• Any subsequent events considered; and
• How any 'rule of thumb' was considered.

The Calculation Engagement, on the other hand, limits the freedom of the appraiser and may not be suitable for a formal unrestricted opinion of value. The valuation analyst and client agree on: 1) the valuation approaches and methods to use; and 2) the extent of procedures to perform. This understanding with the client can be oral (with work paper documentation) or in written correspondence. Scope restrictions on the valuation analyst's work or on data availability should be disclosed in the calculation report. Results are expressed as a 'calculated value' ' either as a single amount or a range of values. In a calculation engagement, you may see language in the report similar to the following:

In a calculation engagement, the valuation analyst and the client agree on the specific valuation approaches and valuation methods the valuation analyst will use, and the extent of valuation procedures the valuation analyst will perform to estimate the value of the subject interest. A calculation engagement does not include all of the procedures required in a valuation engagement, as that term is defined in SSVS 1. Had a valuation engagement been performed, the results might have been different.

Nonetheless, a calculation engagement is not a quick and simple procedure. Considerations (which should be disclosed and documented in the work paper file) include:

• Identity of the client;
• Identity of the subject interest;
• Ownership control and marketability elements;
• Purpose and intended use of the calculated value;
• Intended users of report and any limitations on the report use;
• The valuation date;
• Applicable standard of value;
• Applicable premise of value;
• The sources of information used;
• Valuation approaches and methods agreed on with client; and
• Any subsequent events.

Written or Oral Report? SSVS 1 allows the accountant/analyst to provide either a written report or an oral report of the results for either a 'conclusion of value' or a 'calculated value.' The more robust valuation engagement allows either a detailed or summary report; the less robust calculation assignment provides for a 'calculation report.' An oral report (suitable for either 'valuation' or 'calculation' engagements) should sufficiently convey scope, assumptions, limitations and results to preclude any misunderstandings between the accountant/analyst and the recipient of the report. The substance of any oral report previously communicated to the client should be documented in the work papers.

Discoverable documents in work files should accompany every oral report. The written detailed report (paragraphs 47 through 70) provides all sufficient information to permit report users to understand the data, reasoning, and analyses underlying the value conclusion. Clients, attorneys and other business valuation professionals should be able to: 1) replicate the data sources and the valuation approaches, methods and procedures; and 2) duplicate the construction of the value conclusion.

The written summary report (paragraphs 71 and 72) provides only an abridged or condensed form of the information that would be provided in a detailed report. Minimum disclosures in a summary report should include the following:

• Identity of the client;
• Purpose and intended use of the valuation;
• Identity of the subject entity;
• Description of the subject interest;
• Subject interest ownership characteristics and degree of marketability;
• Valuation date;
• Valuation report date;
• Type of report issued (i.e., a summary report);
• Applicable standard of value;
• Applicable premise of value;
• Sources of information used in the valuation;
• Any assumptions and limiting conditions;
• Any restrictions/limitations on the scope of work or the data availability;
• Any hypothetical conditions assumed;
• Description of any other specialist's work relied on and the level of responsibility the valuation analyst assumes for the specialist's work;
• Valuation approaches and methods used;
• Reconciliation of value estimates and conclusion of value;
• Disclosure of any subsequent events;
• Any jurisdictional exception;
• Representation of the valuation analyst; and
• Signature of valuation analyst or analyst's firm

The written calculation report (paragraphs 73 through 77) should identify that the work performed was a calculation, and summarize the calculated value, including:

• Identification of the subject interest;
• Identification of the calculation date;
• Valuation report date;
• Statement that the valuation analyst is not obligated to update the calculation;
• Description of the calculation procedures performed;
• Statement that calculation was performed in accordance with SSVS 1;
• Description of the subject interest characteristics, including characteristics of control and marketability;
• A statement that the estimated value is a calculated value;
• A general description of the calculation engagement;
• The calculated value; and
• Signature of the valuation analyst or the valuation analyst's firm

Thoughts for Your Practice

For assignments where the matrimonial attorney hires a valuation analyst after Jan. 1, 2008 subject to the new AICPA standards, expect a good deal of effort devoted to the assignment. A 'quick and simple' estimate of equity value in a closely held company may be much more difficult to find among professionals in accounting firms. The issue of whether or not your valuation analyst in a calculation engagement has offered an opinion of value suitable for litigation purposes in a dissolution setting is unsettling, and may be the focus of attack from opposing counsel when a less than full scope analysis (or 'procedures agreed to with the client') is offered in evidence. Oral reports (with discoverable work files) should be supported by sufficient detail in the work papers, and may pose unusual difficulty for the expert witness to ensure compliance and consistency with the newly expected detailed procedures.

Looking ahead, the most common type of appraisal service from accountants to matrimonial attorneys may be a valuation engagement with a summary report. On the other hand, the most dangerous type of service offered by accountants in the years ahead may be a calculation engagement with an oral report. Know what you get!

Unfortunately for clients, professional fees will probably rise. The numbers of accountants who choose to undertake matrimonial valuation work may also shrink, due to the implied level of sophistication and diligence that will be expected. Overall, the bar is raised among accountants who analyze value. Be prepared to expect more and expose those who don't provide it!

Robert C. Schlegel, a member of this newsletter's Board of Editors, is a Principal with Houlihan Valuation Advisors in Indianapolis, IN. Jason Thompson is a Partner in the Business Valuation/Litigation Services Group with Greenwalt Sponsel & Co., Inc., an Indianapolis CPA firm.