Running a valuation practice is complex and has many moving parts. You may have questions about how to manage issues around business valuation approaches and or adjustments. This FAQ will answer common scenarios a valuation analyst may find him or herself in.
If the valuation analyst uses a subject company’s general ledger and prepares financial statements that will be presented as part of the business valuation report, does the valuation analyst or his/her firm have to comply with Statements on Standards for Accounting and Review Services (SSARSs),including the performance and reporting requirements for a compilation engagement with respect to those financial statements?
Yes. Paragraph .01 of AR section 80, Compilation of Financial Statements states that the accountant is required to comply with the provisions of AR section 80 whenever he or she submits financial statements to a client or to third parties. Paragraph .04 of AR section 60, Framework for Performing and Reporting on Compilation and Review Engagements defines submission of financial statements as “presenting to management financial statements that the accountant has prepared”.
Commentary:
If the valuation analyst uses the subject company’s general
ledger to prepare financial statements and presents such financial statements
in the business valuation report, there is a requirement to compile those
financial statements in accordance with SSARSs, including providing a
compilation report.
In the course of developing a business valuation in accordance with the Statement on Standards for Valuation Services, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset (“VS Section 100” or “SSVS”), a valuation analyst may make certain normalization or control adjustments to the financial statements (audited, reviewed, compiled or internally prepared) provided by the subject entity. Is the valuation analyst required to compile this adjusted financial information in accordance with SSARSs?
No. Normalization and control adjustments are considered pro forma adjustments. Paragraphs .03-.04 of AR section 120, Compilation of Pro Forma Financial Information states:
“The objective of pro forma financial information is to show what the significant effects on historical financial information might have been had a consummated or proposed transaction (or event) occurred at an earlier date. Pro forma financial information is commonly used to show the effects of transactions such as the following: business combinations, changes in capitalization, disposition of a significant portion of the business, change in the form of business organization or status as an autonomous entity, or proposed sale of securities and the application of the proceeds.”
“This objective is achieved primarily by applying pro forma adjustments to historical financial information ....”
Further, paragraph .01 of AR section 120 “.... By definition, presentations of pro forma financial information are not financial statements.”
The International Glossary of Business Valuation Terms (Appendix B in VS SECTION 100) defines Normalized Earnings as “....economic benefits adjusted for nonrecurring, noneconomic, or other unusual items to eliminate anomalies and/or facilitate comparisons.”
Commentary:
The adjustments (whether normalization adjustments or control adjustments) made to the subject entity’s financial statements by the valuation analyst are typically designed to adjust for unusual items or to eliminate anomalies and facilitate comparisons. They are in the nature of pro forma adjustments which result in presentations of financial information that, by definition, are not financial statements. There is no requirement to report on the adjusted financial information unless the valuation analyst or his/her firm has been separately engaged to do so. It would be beneficial if the adjusted financial information would be labeled as “pro forma financial information.”
If the valuation analyst receives internally prepared company financial statements and retypes them for side by side comparison in the valuation report, the valuation analyst is not required to compile those internally prepared company financial statements in accordance with SSARSs. See VS SECTION 100, Appendix A, Assumption 2.
If the information provided to the valuation analyst by the subject entity is tax return information and the valuation analyst makes adjustments to the tax return information, is the valuation analyst or his/her firm required to prepare a compilation report?
No. Tax return information, by definition, is not a financial statement. Therefore, adjustments to tax return information does not change its nature into that of a financial statement.
Commentary:
Adjustments to tax return information are also in the nature of pro forma adjustments. They are designed to eliminate anomalies or unusual items. The result is adjusted financial information on which there is no requirement for the valuation analyst to report.
If the valuation analyst receives historical tax returns and retypes the tax return information for side by side comparison in the valuation report, there is no requirement for the valuation analyst to report on this retyped tax return information. See VS SECTION 100, Appendix A, Assumption 2.