Last year, the AICPA issued Statement on Standards for Valuation Services (SSVS) No. 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset, effective for all engagements accepted on or after January 1, 2008. The new standards apply to any AICPA member, or a nonmember CPA practicing in a state that has adopted SSVS No. 1, who is engaged to estimate the value of a business, business ownership interest, security, or intangible asset.
The various state boards of accountancy have traditionally looked to the standards imposed by the AICPA to represent best practices and to define minimum technical standards of competence. Practitioners performing valuation services, including those who are not AICPA members, who do not comply with the new standards may be subject to later criticism or encounter difficulty while defending their valuation because of their noncompliance with their profession’s best practices.
The standards reach beyond valuation engagements in their application. The statement applies to any engagement that contains an estimate of value including tax, litigation, or acquisition-related engagements. Tax practitioners can become involved in valuation estimates through a variety of tax engagements, including corporate reorganizations, S corporation conversions, purchase price allocations, charitable contribution deductions, and various tax planning matters. SSVS No. 1 will affect how such a value is determined and how the use of the valuation is communicated to the client.
Prior to determining the applicability of SSVS No. 1 to a particular engagement, it is essential to understand the terms used in the statement.
The standards apply to the valuation of a subject interest, defined as a business, business ownership interest, security, or intangible asset. The standard recognizes two types of engagements to estimate value: a valuation engagement and a calculation engagement. The valuation engagement results in a conclusion of value and the calculation engagement results in a calculated value (SSVS No. 1, ¶¶1, 21).
An AICPA member, or otherwise covered CPA, performing the estimate of value is a valuation analyst. SSVS No. 1 provides guidance in the performance of both valuation and calculation engagements. At the conclusion of a valuation engagement, the valuation analyst must issue a report, either written or oral, containing the conclusion of the subject interest’s value.
Valuations in Tax Practice
When will SSVS No. 1 apply to a tax engagement? Consider the following fact pattern.
Example: J and M, a married couple, have engaged a tax practitioner, T, to assist them in developing their estate plan. As part of the engagement, T is asked to determine their current estimated estate tax liability as a starting point of their estate planning. One of J and M’s major assets is a closely held corporation. In order to compute their current estimated estate tax liability, T will need to use a value for this closely held business interest.
Now consider each of the following circumstances:
1. The client provides the value to be used for purposes of the estimate: SSVS No. 1 does not apply when the subject interest’s value is provided to the member by the client or a third party and the member does not apply valuation approaches and methods (SSVS No. 1, ¶6).
2. The client asks the practitioner to calculate the value of the subject interest by applying a long-accepted “rule of thumb” to the financial information provided by the client: This type of engagement is covered by SSVS No. 1 as a calculation engagement. A valuation analyst performs a calculation engagement when (1) the valuation analyst and the client agree on the valuation approach and methods the valuation analyst will use and on the extent of procedures the valuation analyst will perform in the process of calculating the value of a subject interest (these procedures will be more limited than those of a valuation engagement), and (2) the valuation analyst calculates the value in compliance with the agreement. The valuation analyst expresses the results of these procedures as a calculated value. This value is expressed as either a range or a single amount (SSVS No. 1, ¶21(b)).
3. The client asks the practitioner to estimate the value of the subject interest: UnderSSVS No. 1, this is a valuation engagement. A valuation analyst performs a valuation engagement when (1) the engagement calls for the valuation analyst to estimate the value of a subject interest, and (2) the valuation analyst estimates the value and is free to apply the valuation approaches he or she deems appro-priate in the circumstances. The valuation analyst expresses the valuation’s results as a conclusion of value; the conclusion may be either a single amount or a range (SSVS No. 1, ¶21(a)).
The Valuation Report
The practitioner may communicate the conclusion of value or the calculated value of the subject interest to the client in a written or oral report (SSVS No. 1, ¶47). If the practitioner is required to use any hypothetical conditions in a valuation or calculation, the practitioner should disclose them in the report and explain the purpose of using them (SSVS No. 1, ¶22). The practitioner should also indicate in the report any restrictions on the report’s use (SSVS No. 1, ¶49). Detailed descriptions of what should be included in written and oral valuation and calculation reports are contained in SSVS No. 1, ¶¶51–78.
SSVS No. 1 contains some general exceptions to its application.
Attest engagement: SSVS No. 1 is not applicable to a CPA who participates in estimating the value of a subject interest as part of performing an attest engagement defined by AICPA Code of Professional Conduct Rule 101 (i.e., as part of an audit, review, or compilation engagement) (SSVS No. 1, ¶5).
Valuation approaches and methods not applied: SSVS No. 1 does not apply if the subject interest’s value is provided to the CPA by the client or a third party and the CPA does not apply any valuation approaches and methods (SSVS No. 1, ¶6).
Internal use assignment to em ployee: SSVS No. 1 is not applicable to internal use assignments from employers to employee members not in the practice of public accounting, as that term is defined in the AICPA Code of Professional Conduct (SSVS No. 1, ¶7).
Determination of economic dam ages: SSVS No. 1 does not apply to an engagement exclusively for the purposes of determining economic damages (e.g., lost profits) unless the determination also includes an en-gagement to estimate value (SSVS No. 1, ¶8).
Mechanical computations: SSVS No. 1 does not apply to mechanical computations that do not rise to the level of an engagement to estimate value—that is, when the member does not apply valuation approaches and methods and does not use professional judgment (SSVS No. 1, ¶9(a)).
Application not practical or reasonable: SSVS No. 1 does not apply when it is not practical or reasonable for the CPA to obtain or use relevant information; as a result, the CPA is unable to apply valuation approaches and methods (SSVS No. 1, ¶9(b)).
Applying SSVS No. 1 in Practice
The following practice situations illustrate whether various tax engagements fall under SSVS No. 1. SSVS No. 1 does not apply to:
- Mathematical calculations of a family limited partnership interest when the partnership owns only publicly traded securities and the CPA relies on public security prices and does not apply any marketability or minority interest discounts;
- Personal tax planning services that estimate the proceeds from a hypothetical future sale of a client’s business interest, including a discussion of valuation concepts or industry pricing multiples based on the CPA’s knowledge, where the discussions help the client determine a hypothetical or assumed value;
- Settlements or negotiations of a business, security, or asset value for purposes of an offer in compromise related to taxation disputes;
- A Sec. 482 intercompany transfer pricing study that involves the use of the specific methodologies, data, terminology, and documentation requirements provided in the Sec. 482 regulations and procedures;
- Preparation of cost segregation studies to allocate the cost of a building structure between the real property and the personal property components;
- Quantification of goodwill as a purchase price residual amount when the client or a third party provides all other tangible and intangible values;
- Valuation of a shareholder’s stock purchase price based on the financial statement-related buy/sell formula provisions of a shareholder’s agreement;
- Calculation of historical business lost profits as a measure of economic damages in a commercial litigation matter;
- Economic damage analyses related to a commercial breach of contract litigation;
- Valuation of inventory, accounts receivable, marketable securities, other investment accounts, or any reserve or allowance as part of an audit engagement; or
- Calculation of a present value discount rate, a direct capitalization rate, or a valuation pricing multiple to be used in a business, security, or intangible asset valuation.
SSVS No. 1 does apply to:
- Valuation of a business or intangible asset to determine insolvency (or solvency) for purposes of recognizing cancellation of indebtedness income;
- Employer corporation stock valuation for purposes of Sec. 409A;
- Valuation of business, business ownership interest, security, or intangible assets for estate or gift tax return compliance purposes;
- Quantification of the value of goodwill using the “formula approach” specified in Rev. Rul. 68-609;
- Valuation of a corporate client’s subsidiaries for purposes of intercompany transfer between domestic ownership and foreign ownership; and
- Valuation of a block of publicly traded stock if blockage, lockup, contractual restrictions, or market transferability restrictions apply.
SSVS No. 1 has a very broad reach across many areas of practice. To help determine the application of this new standard to areas of tax practice, the AICPA has published a practice aid: AICPA Statement on Standards for Valuation Services No. 1, Nonauthoritative Implementation Guidance Toolkit, Implementation Guide No. 1: Application of SSVS No. 1 to Various Illustrative Client Engagement Situations.
This practice aid lists 53 types of engagements where SSVS No. 1 does not apply and 52 engagements where it does apply. The aid can be downloaded, along with several other practice aids and the text of the standards themselves, from the AICPA Forensic and Valuation Services website (http://fvs.aicpa.org).
Editor’s note: This article is adapted from Florida CPA Today with permission of the Florida Institute of CPAs.