A CPA who is asked what a business is worth is doing professional work under a specific standard. AICPA members who perform engagements to estimate value must follow the Statement on Standards for Valuation Services No. 1, codified as VS Section 100 in the AICPA Professional Standards. The scope of the work, the type of conclusion and the report all follow from which kind of engagement the CPA accepts. This article explains the framework and the file a firm should build.
Status and scope
The AICPA Consulting Services Executive Committee issued SSVS No. 1 in June 2007, effective for engagements accepted on or after January 1, 2008. It is codified as VS Section 100 in the AICPA Professional Standards. The AICPA page states that members must follow it when they perform engagements to estimate value that culminate in the expression of a conclusion of value or a calculated value.
The standard covers valuations of a business, business interest, security or intangible asset for purposes such as transactions, financing, taxation, financial reporting and litigation. It contains exceptions to its requirements, which are set out in the standard itself. The AICPA notes that non-members should check with their state board of accountancy to see if the standard applies to them.
Two kinds of engagement
Valuation engagement. The CPA is free to apply the valuation approaches and methods the CPA considers appropriate in the circumstances and expresses a conclusion of value, which may be a single amount or a range.
Calculation engagement. The CPA and the client agree in advance on the valuation approaches and methods the CPA will use and the extent of the procedures. The CPA applies those agreed approaches and methods and expresses a calculated value, which may be a single amount or a range. The calculation report describes the limited scope.
The distinction is the breadth of the CPA's freedom to choose procedures. A calculation engagement is narrower and cheaper, and it gives a less supported result. Clients sometimes ask for a valuation and want a calculation price, and the engagement letter has to settle which one is being performed.
The three approaches
The standard addresses the commonly used approaches:
- Income approach. Value based on the present value of expected future economic benefits, such as discounted cash flow or capitalization of earnings.
- Market approach. Value based on prices of comparable businesses or securities, using guideline public companies or transactions.
- Asset-based approach. Value based on the fair value of assets less liabilities.
The IRS Business Valuation Guidelines describe the same three approaches as the generally accepted ones and state that appraisers should consider all three and use judgment to select the approaches and methods that best indicate value. The IRS guidance also lists factors that include the nature and history of the business, the economic and industry outlook, financial condition, earnings capacity, dividend capacity, goodwill, prior sales of the interest and market prices of comparable companies. See business valuation approaches in practice.
Before accepting
The engagement acceptance decision under VS 100 follows the general standards that apply to all AICPA members: professional competence, due professional care, planning and supervision, and sufficient relevant data. Independence is not required for valuation as a nonattest service, but the member has to consider whether a valuation for an attest client threatens independence. See independence and nonattest services for small firms.
Scope items to settle in writing
- Subject. The entity, the interest, the class of shares and any rights or restrictions.
- Purpose and intended users. A valuation for a buy-sell agreement, a gift tax return, a divorce, financial reporting or a transaction each carries a different standard of value and different risks.
- Standard and premise of value. Fair market value, fair value or another standard, and going concern or liquidation.
- Valuation date. The date as of which value is estimated.
- Type of engagement. Valuation or calculation, with the report type.
- Information and reliance. What management provides, what the CPA verifies and what the CPA does not audit.
- Fee basis. How the fee is set. A fee that depends on the conclusion raises professional conduct questions that must be settled before acceptance.
- Restrictions on use. The users and purposes the report is limited to.
The file
A valuation file should contain the engagement letter, the financial statements and adjustments to them, the normalization schedule with support, the industry and economic analysis, the approaches and methods used with reasons for the ones rejected, the inputs and sources for each assumption, the computation, the reconciliation of indications to the conclusion and the report. Keep the management representation letter too. For related financial reporting valuations, see 409A valuation guidance for CPAs and fair value measurement under ASC 820.
Common problems
- Accepting a calculation engagement and delivering the conclusion language of a valuation.
- Using a single method without explaining why the others were rejected.
- Normalizing earnings without support.
- Applying discounts for lack of marketability or control without describing the basis. The IRS guidelines say the appraiser should separately consider marketability and control, as appropriate for the assignment.
- Failing to define the standard of value in the engagement letter.
FAQ
Is a calculation engagement a lower-quality valuation?
It is a different engagement with an agreed, limited scope, and its report says so.
Does VS 100 apply to non-CPA valuators?
The AICPA says non-members should check with their state board of accountancy.
Can the report conclude with a range?
Yes. Both conclusions of value and calculated values may be a single amount or a range.
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Sources
- AICPA, Statement on Standards for Valuation Services, VS Section 100: https://www.aicpa-cima.com/resources/download/statement-on-standards-for-valuation-services-vs-section-100
- AICPA, Statement on Standards for Valuation Services (SSVS) / VS Section 100 Toolkit: https://www.aicpa-cima.com/resources/toolkit/vs-section-100-toolkit
- Journal of Accountancy (AICPA), Professional guidance in business valuation: applying SSVS 1 (September 2007): https://www.journalofaccountancy.com/issues/2007/sep/professionalguidanceinbusinessvaluationapplyingssvs1/
- IRS, Internal Revenue Manual 4.48.4, Business Valuation Guidelines: https://www.irs.gov/irm/part4/irm_04-048-004
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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error