IVSC Website

UNITY UNIVERSITY

ACCOUNTING AND FINANCE DEPARTMENT

ADVANCED FINANCIAL ACCOUNTING I(ACFN 4011)

 CHAPTER SIX

ASSET VALUATION FOR FINANCIAL REPORTING

References
 IVSC (2013) International valuation standards.
 www.ivsc.org
 Contents of the chapter
6. Basics of valuation
6.1. Overview of International Valuation Standards (IVS)
6. 2. Valuation approaches
6.1.1. Market approach
6.1.2. Income approach
6.1.3. Cost approach
6.1.4. Valuation report
 Terminologies related with valuation
• Subject Asset/assets refers to items that might be
subject to a valuation engagement.
• Such as “asset, group of assets, liability, group of
liabilities, or group of assets and liabilities”.

• Basis (bases) of Value The fundamental premises on

which the reported values are or will be based.
 Terminologies related with valuation
• Value It is an estimate of either the most probable monetary
consideration for an interest in an asset or the economic benefits of
holding an interest in an asset on a stated basis of value. The opinion
resulting from a valuation process

• Valuer an individual, group of individuals or individual within an

entity, regardless of whether employed (internal) or engaged
(contracted/external), possessing the necessary qualifications, ability
and experience to execute a valuation in an objective, unbiased, ethical
and competent manner
 Terminologies related with valuation
Client- the person, persons, or entity for whom the valuation is performed.

Discount Rate(s) -A rate of return used to convert a monetary sum, payable or receivable in the
future, into a present value.

Participant- the relevant participants pursuant to the basis (or bases) of value used in a valuation
engagement such as those of “market participants” (eg, market value, IFRS fair value) or a
particular owner or prospective buyer (eg, investment value).

Valuation-It is the act or process of determining an opinion or conclusion of the value of an asset
on a stated basis of value at a specified date in compliance with IVS.
 Terminologies related with valuation

• Valuation Approach: It is a way of estimating value that employs one or more

specific valuation methods.

• Valuation Method: Within valuation approaches, a specific way to estimate a value.

• Valuation reviewer: A professional valuer engaged to review the work of another
valuer.

• Purpose of valuation: refers to the reason(s) of a valuation is performed.

Such as financial reporting, tax reporting, litigation support, transaction support, and to support
secured lending decisions.
 International Valuation Standards (IVS)
• The International Valuation Standards (IVS) are international
standards that consist of various actions required during the undertaking
of a valuation assignment supported by technical information and
guidance.

• Objective of the IVS is to increase the confidence and trust of users of

valuation services by establishing transparent and consistent valuation
procedures.
• The International Valuation Standards Council (IVSC) is an
independent, not-for-profit organization committed to advancing quality
in the valuation profession.
The IVSC – Structure
Board of Trustees:
Strategy, Governance
and
Fund-raising

Standards Board: Professional Board:

Standards and Technical Development and Promotion
Guidance of the Valuation Profession

11 11
Core Principles of Valuation
1. Ethics-Valuers must follow the ethical principles of integrity, objectivity, impartiality,
confidentiality, competence and professionalism

2. Competency-valuers must have the technical skills and knowledge required to

appropriately complete the valuation assignment.

3. Compliance-Valuers must disclose or report the published valuation standards used

for the assignment and comply with those standards.
4. Basis (i.e., Type or Standard) of Value-Valuers must select the basis (or bases) of
value appropriate for the assignment and follow all applicable requirements. The basis
of value (or bases) must be either defined or cited.
5. Date of Value (ie, Effective Date/Date of Valuation)
6. Assumptions and Conditions

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 CON….D
7. Intended Use
8. Intended User(s)
9. Scope of Work- Valuers must determine, perform, and disclose or report a scope of work that
is appropriate for the assignment that will result in a credible valuation.
10. Identification of Subject of Valuation
11. Data- Valuers must use appropriate information and data inputs in a clear and transparent
manner so as to provide a credible valuation.
12. Valuation Methodology- Valuers must properly use the appropriate valuation
methodology(ies) to develop a credible valuation.
13. Communication of Valuation-Valuers must clearly communicate the analyses,
opinions and conclusions of the valuation to the intended user(s).
14. Record Keeping-Valuers must keep a copy of the valuation and a record of the
valuation work performed for an appropriate period after completion of the assignment.
(key inputs, all calculations, investigations and analyses)
The IVS are arranged as follows: contain five different types of pronouncement.

 The IVS Framework- contains concepts and principles that are to be followed
when applying the IVSs, but does not include any required actions.

•IVS General Standards -contain actions that are required when setting up, carrying
out and reporting a valuation.

 IVS Asset Standards- contain any additional requirements for each of the main
genres of asset, together with guidance on key issues that affect the valuation of
that type of asset that need to be considered.

 The IVS Application Standards- contain additional requirements for the specified
valuation purpose and guidance on matters that may be typically encountered.

 The Technical Information Papers -contain guidance on complying with specific

requirements in one or more of the other standards or on dealing with matters
where there is evidence of diverse practice.
 IAS- General Standards

IVS -101 Scope of Work

IVS 102 –Investigations and Compliance
IVS 103 –Reporting
IVS-104-Bases of Value
IVS-105-Valuations approaches and Methods
Asset Standards
•IVS 200 - Business and Business Interests.
•IVS 210 - Intangible Assets.
•IVS 220 – Non-Financial Liabilities.
•IVS 230 - Inventory.
•IVS 300 - Plant and Equipment.
•IVS 400 - Real Property Interests.
•IVS 410 - Development Property.
•IVS 500 - Financial Instruments.
 Basis (Bases) of value
• Bases of value/valuation (sometimes called standards of value)
describe the fundamental premises on which the reported values will
be based.

• It is critical that the basis (or bases) of value be appropriate to the

terms and purpose of the valuation assignment, as a basis of value
may influence or dictate a valuer’s selection of methods, inputs and
assumptions, and the ultimate opinion of value.
 IVS - defined bases of value
1. Market value
2. Market rent
3. Equitable value
4. Investment value/worth
5. Synergistic value and
6. Liquidation value
 1. Market Value
• Market value is the estimated amount for which an asset or liability
should exchange on the valuation date between a willing buyer and a
willing seller in
• In an arm’s length transaction,
• After proper marketing
And where the,
• Parties had each acted knowledgeably,
• Prudently,
• Without compulsion.
 2. Market Rent
• Market rent is the estimated amount for which an interest in real property should be
leased on the valuation date between a willing lessor and a willing lessee on
appropriate lease terms:
• In an arm’s length transaction,
• After proper marketing
And where the,
• Parties had each acted knowledgeably,
• Prudently,
• Without compulsion.
• Market rent may be used as a basis of value when valuing a lease or an interest
created by a lease. In such cases, it is necessary to consider the contract rent and,
where it is different, the market rent.
 3. Equitable Value
• Equitable value is the estimated price for the transfer of an asset or
liability b/n identified knowledgeable and willing parties that reflect the
respective interests of those parties.

• Equitable value requires the assessment of the price that is fair between
two specific, identified parties considering the respective advantages or
disadvantages that each will gain from the transaction.
• In contrast, market value requires any advantages or disadvantages that
would not be available to, or incurred by, market participants generally to
be disregarded.
 4. Investment Value/Worth
• Investment value is the value of an asset to a particular owner or prospective
owner for individual investment or operational objectives.

• Investment value is an entity-specific basis of value.

• Although, the value of an asset to the owner may be the same as the amount
realized from its sale to another party, this basis of value reflects the benefits
received by an entity from holding the asset and, therefore, does not involve a
presumed exchange.

• It is often used for measuring investment performance.

 5. Synergistic Value
• Synergies refer to the benefits associated with combining assets. When
synergies are present, the value of a group of assets and liabilities is
greater than the sum of the values of the individual assets and liabilities.

• Synergistic value is the result of a combination of two or more assets or

interests where the combined value is more than the sum of the separate
values.

• The added value above the aggregate of the respective interests is often
referred to as “marriage value.”
 6. Liquidation Value
• Liquidation Value is defined as the net amount that would be realized if the
business is terminated and the assets are sold piecemeal for the purpose of attaining
liquidity as promptly as a prudent person could for distribution to members.

• Liquidation value should take into account the costs of getting the assets into
saleable condition as well as those of the disposal activity.

• Liquidation value can be determined under two different premises of value:

(a) an orderly transaction with a typical marketing period
(b) a forced transaction with a shortened marketing period
 Other bases of value (non-exhaustive list)

1. Fair value (International Financial Reporting Standards)

2. Fair market value (Organization for Economic Co-operation and
Development)
3. Fair market value (the United States Internal Revenue Service)
4. Fair value (Legal/Statutory)
Premise of Value/Assumed Use

Some common premises of value are:

(a) Highest and best use,
(b) Current use/existing use,
(c) Orderly liquidation, and
(d) Forced sale.

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 Valuation Approaches and Methods
• The three principal valuation approaches described in IVS 105 Valuation
Approaches may be applied to the valuation of businesses and business
interests are:
Market Approach
Income Approach
Cost Approach
CONT..D
The selection process should consider, at a minimum:
(a) the appropriate basis(es) of value and premise(s) of value, determined by the
terms and purpose of the valuation assignment,

(b) the respective strengths and weaknesses of the possible valuation

approaches and methods,

(c) the appropriateness of each method in view of the nature of the asset, and
the approaches or methods used by participants in the relevant market, and

(d) the availability of reliable information needed to apply the method(s).

 1. Market Approach
• The market approach provides an indication of value by comparing
the asset with identical or comparable (that is similar) assets for which
price information is available

• When reliable, verifiable, and relevant market information is

available, the market approach is the preferred valuation approach.
 Market Approach……….
The market approach should be applied and afforded significant
weight under the following circumstances:

the subject asset has recently been sold in a transaction appropriate for
consideration under the basis of value,
the subject asset or substantially similar assets are actively publicly
traded, and/or
there are frequent and/or recent observable transactions in
substantially similar assets
 Market Approach……….
Additional circumstances
• Although the above circumstances would indicate that the
market approach should be the primary basis for a valuation,
when the above criteria are not met, the following are additional
circumstances where the market approach may be appropriate.

• When using the market approach under the following

circumstances, a valuer should consider whether any other
approaches can be used to corroborate the value indication from
the market approach:
 Market Approach……….
a. Transactions involving the subject asset or substantially similar assets are not
recent enough considering the level of volatility in the market,
b. The asset or substantially similar assets are publicly traded, but not actively,
c. Information on market transactions is available, but the comparable assets
have significant differences from the subject asset, potentially requiring
subjective adjustments,
d. Information on recent transactions is not reliable (ie, hearsay, missing
information, synergistic purchaser, not arm’s-length, distressed sale, etc),

e. The critical element affecting the value of the asset is the price it would
achieve in the market rather than the cost of reproduction or its income-
producing ability (for example, shopping center, artwork, heritage assets).
 Market Approach……….
• There must be a reasonable basis for comparison with, and reliance upon,
similar businesses in the market approach.
• Factors that should be considered in assessing whether a reasonable basis for
comparison exists include:

A. similarity to the subject business in terms of qualitative and quantitative business

characteristics,
B. amount and verifiability of data on a similar business, and
C. whether the price of a similar business represents an arm’s length and orderly
transaction
 Market Approach Methods
I. Comparable Transactions Method
• The comparable transactions method, also known as the guideline
transactions method, utilizes information on transactions involving assets that
are the same or similar to the subject asset to arrive at an indication of value.

• If few recent transactions have occurred, the valuer may consider the prices of
identical or similar assets that are listed or offered for sale, provided the
relevance of this information is clearly established, critically analyzed, and
documented.
 Market Approach Methods………
II. Guideline publicly-traded comparable method

• The guideline publicly-traded method utilizes information on publicly-traded

comparable that are the same or similar to the subject asset to arrive at an indication of
value.

• This method is similar to the comparable transactions method. However, there are several
differences due to the comparable being publicly traded, as follows:
a) Valuation metrics/comparable evidence are available as of the valuation date,
b) Detailed information on the comparable is readily available in public filings, and
c) The information contained in public filings are prepared under well-understood
accounting standards
 2. Income Approach
• Income approach provides an indication of value by converting future
cash flow to a single current value.
• In this approach, the value of an asset is determined by reference to the
value of income, cash flow, or cost savings generated by the asset.
• A fundamental basis for the income approach is that investors expect to
receive a return on their investments and that such a return should reflect
the perceived level of risk in the investment.

• Generally, investors can only expect to be compensated for systematic

risk (also known as “market risk” or “undiversifiable risk”).
 • Income approach should be applied and afforded significant
weight under the following circumstances:

1. Income-producing ability of the asset is the critical element affecting

value from a participant’s perspective.

2. Reasonable projections of the amount and timing of future income

are available for the subject asset, but there are few, if any, relevant
market comparable.
 Income Approach………
Additional circumstances where the income approach may be applied and
afforded significant weight.
the income-producing ability of the subject asset is only one of several factors
affecting value from a participant’s perspective,
there is significant uncertainty regarding the amount and timing of future
income related to the subject asset,
there is a lack of access to information related to the subject asset (for example,
a minority owner may have access to historical financial statements but not
forecasts/budgets), and/or
the subject asset has not yet begun generating income but is projected to do so.
 Income Approach Method
• Discounted Cash Flow (DCF) Method

• Under the DCF method the forecasted cash flow is discounted back to the
valuation date, resulting in a present value of the asset.

• In some circumstances for long-lived or indefinite-lived assets, DCF may

include a terminal value that represents the value of the asset at the end of the
explicit projection period (income capitalization method. ).
 The key steps in the DCF method are
1) Choose the most appropriate type of cash flow for the nature of the subject
asset and the assignment (i.e., pre-tax or post-tax, total cash flows or cash
flows to equity, real or nominal, etc.),
2) Determine the most appropriate explicit period, if any, over which the cash
flow will be forecast,
3) Prepare cash flow forecasts for that period,
4) Determine whether a terminal value is appropriate for the subject asset at
the end of the explicit forecast period (if any) and then determine the
appropriate terminal value for the nature of the asset,
5) Determine the appropriate discount rate, and
6) Apply the discount rate to the forecasted future cash flow, including the
terminal value, if any.
 3. Cost Approach
• The approach provides an indication of value by calculating the
current replacement or reproduction cost of an asset and making
deductions for physical deterioration and all other relevant forms of
obsolescence.

• The cost approach provides an indication of value using the economic

principle that a buyer will pay no more for an asset than the cost to
obtain an asset of equal utility, whether by purchase or by
construction, unless undue time, inconvenience, risk or other factors
are involved.
 Cost Approach…….
• Cost approach should be applied and afforded significant weight under the
following circumstances:
participants would be able to recreate an asset with substantially the same
utility as the subject asset, without regulatory or legal restrictions, and the asset
could be recreated quickly enough that participants would not be willing to pay
a significant premium for the ability to use the subject asset immediately,
the asset is not directly income-generating and the unique nature of the asset
makes using an income approach or market approach unfeasible, and/or
the basis of value being used is fundamentally based on replacement cost, such
as replacement value.
 Cost Approach…….
Additional circumstances where the cost approach may be applied and afforded
significant weight.

Participants might consider recreating an asset of similar utility, but there are
potential legal or regulatory hurdles or significant time involved in recreating the
asset,

When the cost approach is being used as a reasonableness check to other

approaches.

The asset was recently created, such that there is a high degree of reliability in the
assumptions used in the cost approach.
 Cost Approach Methods
1) Replacement Cost Method

• Generally, replacement cost is the cost that is relevant to determining the

price that a participant would pay as it is based on replicating the utility of
the asset, not the exact physical properties of the asset.

• Usually replacement cost is adjusted for physical deterioration and all

relevant forms of obsolescence.
 Cost Approach Methods……….
• The key steps in the replacement cost method are:
i. Calculate all of the costs that would be incurred by a typical
participant seeking to create or obtain an asset providing equivalent
utility.
ii. Determine whether there is any deprecation related to physical,
functional, and external obsolescence associated with the subject
asset.
iii. Deduct total deprecation from the total costs to arrive at a value for
the subject asset.
 Cost Approach Methods……….
2) Reproduction Cost Method
• Reproduction cost is appropriate in circumstances such as the following:

The cost of a modern equivalent asset is greater than the cost of recreating
a replica of the subject asset, or

The utility offered by the subject asset could only be provided by a replica
rather than a modern equivalent.
 Cost Approach Methods……….
• The key steps in the reproduction cost method are:

I. Calculate all of the costs that would be incurred by a typical participant

seeking to create an exact replica of the subject asset,
II. Determine whether there is any deprecation related to physical,
functional, and external obsolescence associated with the subject asset,
and
III. Deduct total deprecation from the total costs to arrive at a value for the
subject asset.
 Cost Approach Methods……….
3) Summation Method
• It is typically used for investment companies or other types of assets or entities for
which value is primarily a factor of the values of their holdings.
• It is a method that calculates the value of an asset by the addition of the separate
values of its component parts.

The key steps in the summation method are:

i. value each of the component assets that are part of the subject asset using
the appropriate valuation approaches and methods.

ii. add the value of the component assets together to reach the value of the
Valuation Reports
The purpose of the valuation, the complexity of the asset being valued and the users’
requirements will determine the level of detail appropriate to the valuation report. The format
of the report should be agreed with all parties.

The report must be sufficient to communicate to the intended users the scope of the valuation
assignment, the work performed and the conclusions reached.

The report should also be sufficient for an appropriately experienced valuation professional
with no prior involvement with the valuation engagement to review the report and understand
the items.
 Valuation Reports

Where the report is the result of an assignment involving the valuation of an asset
or assets, the report must convey the following to the minimum.

(a) Scope of the work performed,

(b) Intended use,
(c) Intended users,
(d) The purpose,
(e) The approach or approaches adopted,
(f) The method or methods applied,
(g) The key inputs used,
(h) The assumptions made,
(i) The conclusion(s) of value and principal reasons for any conclusions reached,
(j) The date of the report (which may differ from the valuation date).
Valuation Reports
Valuation Review Reports
Where the report is the result of a valuation review, the report must convey the following, at a
minimum:

 The scope of the review performed

 The valuation report being reviewed and the inputs and assumptions upon which that
valuation was based
 The reviewer’s conclusions about the work under review, including supporting reasons, and
 The date of the report (which may differ from the valuation date).
End of the chapter six

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