One question that business owners often ask their accountants is “what is the value of my business?” While the only true indication of value is determined when there is a willing and able buyer, there are established business valuation methods used to estimate the value of most any business venture. This can either be a fairly straight forward process or require complex calculations and specialized skills, depending on the complexity and uniqueness of the business. As a result, the process for determining an estimated value will vary and so will the extent of valuation services.
To help distinguish between the different levels of services for estimating the value of businesses or ownership interests, valuation services are divided into two types: “valuation engagements” and “calculation engagements.”
CPAs are required to follow standards established by the American Institute of Certified Public Accountants (AICPA) governing business valuations; therefore, distinguishing between the two is of most importance. These standards, known as the AICPA’s Statement on Standards for Valuation Services No. 1 (SSVS1), indicate CPAs should clarify in advance whether they are offering a valuation or calculation engagement. SSVS1 spells out what constitutes a valuation verses a calculation, and it describes when and how each is performed.
According to the AICPA, a valuation engagement results in a “conclusion of value,” which is basically an opinion on the value of the business or ownership interest, and it requires significantly more procedures than a calculation engagement. These engagements, often referred to as full-blown valuations, are more extensive and cost more than a calculation engagement due to the CPA expressing an independent conclusion of value after considering all applicable approaches and methods that are deemed necessary to support their opinion.
As a result, these are typically used if the client’s situation is at risk of ending up in court, or is used to support gift and estate tax filings.
Here are some of the most significant aspects of a valuation engagement:
- It is performed when the situation calls for the analyst to estimate the value of a subject interest.
- The analyst performing a valuation engagement is free to apply the valuation approaches and methods deemed most appropriate for the circumstances, though all three valuation methods (asset-based, income-based and market-based) must be considered.
- The results of the valuation are expressed as a conclusion of value, which can either be a single amount or a range.
Within valuation engagements, there are two levels of reports that are typically offered: a summary report or a detailed report, for which a valuation analyst provides more in-depth research.
This type of engagement does not incorporate all of the procedures required for a valuation engagement and is normally less costly. Under AICPA standards, the valuation professional and client must agree in advance on a) the approaches and methods that will be used and b) the extent of procedures that will be used to calculate the value of a business or interest. The valuation analyst calculates the value based on the agreed to criteria.
The results of these engagements are expressed as a calculated value, and the conclusion can either be a single amount or a range. Procedures tied to a calculation engagement are more limited in scope and, therefore, the calculation “may or may not represent the actual value of the subject interest.” Indeed, valuation professionals normally qualify calculated values by stating that the results might have been different if a valuation engagement had been performed instead.
Calculations of value can be useful for business and succession planning and to help negotiate settlements outside of court. If the settlement falls through or if a conclusion of value is later needed, the calculation engagement can be upgraded to a valuation engagement by performing additional procedures.
In summary, different circumstances require varying levels of service when it comes to business valuations. These levels correspond to the levels of assurance provided by the engagements. In other words, in the same way accountants provide increasing levels of assurance for financial statements as they provide compilations, reviews and audits, valuation professionals offer increasing assurance for business valuations as they provide calculations, summary valuations and detailed valuations.