Professional Documents
Culture Documents
GROUP 2 RESEARCH
Prepared by:
Adrales, Deverly Dawn
Afos, Danica
Aragon, Jeremiah
Barsolaso, Ella Necolle
Hernandez, Cheddy
Josef, Andrea Jessa
Laplano, Fernalou
Liquigan, Oshwald
Maderazo, Abegail
Notarte, Nove
Pabello, Jarelle Joy
Robin, Rheza Mae
Surat, Kristine Marie
Vacal, Cyra
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Table of Contents
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Learning Objectives
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It is the price that would be agreed on between two parties that are willing to pay
for an asset, given the following conditions:
● Both parties are well informed about the condition of the asset.
● Behaving in their own best interest.
● Neither party is under undue pressure to buy or sell the item; and
● There is no time pressure to complete the deal.
If these conditions are present, the final price established between the parties
should reasonably reflect the fair market value of the asset or liability on the date of the
transaction. When it is not possible to have such a transaction, it may be possible to
estimate fair market value based on a cluster of data points from prior actual market
transactions, extrapolated for the asset or liability that is under review.
Fair Value is the statutory standard of value usually used in court cases involving
dissenting shareholders and other similar types of litigation.
Liquidation Value is the expected amount that could be obtained from the piecemeal
sale of business assets on either an orderly or forced liquidation basis.
Investment Value is the value to a specific buyer or investor often based on perceived
synergies when the business is combined with another business. This standard of value
is often used in merger and acquisitions.
Fair value of an asset is the price that would be received to sell an asset in an
orderly transaction between market participants. Fair value is of liability is the price that
would be paid to transfer a liability in an orderly transaction between market
participants. (CFAS, 2019)
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● Market value is dependent on supply and demand in the market where the
asset is bought and sold.
Example: If the owner tries to sell a property for $200,000 during a low time in
the real estate market, then it might not get sold because the demand is low. But
if it is offered for $500,000 during a high time, it may get sold at that price.
b) An exit price. It is the price to sell an asset rather than the price to buy
one. An exit price embodies expectations about the future cash inflows and cash
outflows associated with an asset or liability from the perspective of a market
participant. (KPMG, 2017)
According to the IRS, fair market value is established when five criteria are met:
1. The property would likely sell for this price on the open market.
2. Both the buyer and the seller are willing to enter into the transaction at this price.
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3. The seller isn't being forced to sell the property, and the buyer isn't being forced
to buy. Neither party is under duress to consummate the transaction.
4. They both have full knowledge of the property, its condition, and all relevant facts
pertaining to it.
The concept of fair market value exists within a specific period of time for the
transaction to occur. The FMV can change if the time period for the transaction
changes. The fair market value of the property is then a fair valuation, or an assessment
of its worth.
1. Legal Situations
In the event of a divorce settlement or payment of damages due to harm caused
to private property, the fair market value of the asset in question is used.
2. Taxation
Fair market value is used to assess the municipal property taxes to be paid by an
owner. Tax deductions are also available on casualty loss and depreciation of assets. In
cases of charitable donations, the fair market value of the donation is used for tax
purposes. Therefore, a taxpayer can claim a tax credit for the fair market value of the
donation made.
The process of price discovery employed by professionals in such a situation is
known as appraisal. However, fair market value is different from appraised value as the
latter represents the worth of the good from only one party’s point of view.
3. Insurance
Fair market value is also determined in cases of insurance claims. If an insured
vehicle gets damaged, the insurance claim is proportional to the current fair market
value of the vehicle and not the price at which the vehicle was originally bought.
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1. The owner of an asset has no special reason to want to own the asset apart from
its ability to generate a return, whether that comes in the form of income from the
asset, the eventual sale of the asset, the saving of cost through ownership of the
asset, or a combination of these factors; and
2. The owner is impartial about the assets if they are all capable of generating the
same expected income with the same likelihood.
In practice, this is not always the case: some owners (collectors, for example) are
not wholly rational about the assets they own, and some assets (such as works of art)
are valuable for non-financial reasons (in addition to the ability to sell them in due
course). Such assets may not be susceptible to a rational valuation approach, or it may
be necessary to limit the use of the approaches that follow.
Income approach
The income approach relies on the underlying financial theory that the value of
an asset is equal to the value of the future income that the rational owner can expect to
obtain from the asset.
1. It relies on information on the asset itself, in the form of views as to the likely
future income that an asset can generate, and
2. All value is assumed to arise from the ability to generate future income.
The most common form of the income approach is to focus on cash (rather than
an accounting measure like income) and use a discounted cash flow (DCF) method.
Market approach
The market approach is a method of determining the value of an asset based on
the selling price of similar assets. It is one of three popular valuation methods, along
with the cost approach and discounted cash-flow analysis.
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The market approach is based on the underlying theme that the wider market
has already done the work of valuing companies and businesses of all kinds, using all
the information available, so the valuer simply needs to find a quoted company (or a
company that has been sold) that is the same as the company being valued, and then
use its quoted valuation (or the sale price) as the value of the subject company.
The market approach seeks to answer the question, “what is the fair market
value of this asset?” To answer this question, the valuator needs to survey recent
transactions involving similar assets. Because these assets are unlikely to be identical
to the one being valued, various adjustments will need to be made.
In situations where limited data is available, the valuator may need to rely on
alternative methods such as the cost approach or discounted cash-flow analysis (DCF).
The primary advantages of the market approach are that it is based on publicly
available data on comparable transactions. As such, it can require fewer subjective
assumptions than alternative approaches. The primary disadvantage of the market
approach is that it can be impractical in situations where few if any comparable
transactions exist, such as in the case of a private company operating in a niche market
with few competitors.
Once comparable companies have been identified, the valuer considers which
statistics to use as a basis for comparison, focusing on those that the market uses as a
guide when valuing companies in the sector, and arrives at relevant multiples of those
statistics (whether trading multiples or transaction multiples). The most commonly used
statistics include:
a. Profit after tax (which might be referred to as ‘earnings’ or ‘net income’) – the
amount generated each year for the benefit of shareholders;
b. Earnings before interest, tax, depreciation and amortization (operating profit)
– the amount generated by the business before taking account of its financing,
the replacement of fixed assets and tax (which is affected by non-operating
decisions);
c. Turnover – the total amount generated from sales, before taking account of any
costs; and
d. Book value of assets.
Cost approach
The cost approach rests on the principle that a buyer would not pay more for an
asset than the cost of replicating that asset, either by buying an alternative or by
recreating it. This is not the same as the historical cost of the entity or business –
historical cost tells us the amount actually spent buying or building the asset at some
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past date or over a period of time, rather than the cost of buying or replicating the asset
on the valuation date, which is better thought of as replacement cost.
Thus, the most usual purpose of the cost approach is to provide a ceiling or floor
on the valuation of an operating business.
Income approach
The income approach is the usual starting point for the valuation of an entire or
controlled entity, whether that entity is a company, a business or a project. This is
because the owner or controller of the entity is likely to have the detailed information
needed to undertake a realistic assessment of expected future cash flows.
It is also useful for unique assets, where market-based comparables are difficult
to find, because the unique features of the asset can be taken into account in the
valuation. From a theoretical point of view, the income approach is almost always
suitable, provided there is some reasonable basis for forecasting future cash flows and
assessing risk. This is because it enables the valuer to make assumptions that are
explicit and capable of being both varied and separately considered.
When an asset is not wholly owned or controlled, the valuer is likely to have less
detailed information available from which to project future cash flows, with the result that
there may be less certainty about the forecast and, hence, a need to reflect the risk that
the expectations might be wrong.
Market approach
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the valuer to pinpoint reasons for differences and hence arrive at a well-founded
valuation.
The difficulty with the market approach lies in its reliance on implicit rather than
explicit assumptions, which makes it difficult for the valuer (and, in due course, a
tribunal) to understand what is really influencing the result. Rather than focus on the key
features of the business being valued, the market approach assumes that all
businesses operating in the same sector are subject to the same influences and that the
entity being valued is likely to perform in future in a similar way to the average of other
businesses. There is less scope to take account of why some businesses perform better
than others, and less scope to recognize entity-specific features such as faster growth,
lack of growth, new developments or the need for restructuring.
Regardless of the type of asset being valued, the market approach studies recent
sales of similar assets, making adjustments for the differences between them. For
example, when appraising real estate, adjustments might be made for factors such as
the square footage of the unit, the age and location of the building, and its amenities.
Advantages:
Disadvantages:
• The method raises questions on how much data is available and how good the
data is.
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The Public Company Comparables Method entails using valuation metrics from
companies that have been traded publicly, which are considered to be rightly similar to
the subject entity. In most situations, direct comparability is hard to attain since a
majority of public companies are not only larger but also more dissimilar to the subject.
2. Precedent Transactions
The Precedent Transactions Method involves deriving value using pricing multiples that
are based on observed transactions of companies in the industry of the subject
company. It is based on the perception that comprehensive company financial data is
not easily available, but there is an availability of transaction value.
Cost approach
Apart from those cases, its most common use is as a check on the
reasonableness of the valuations derived from the income and market approaches.
❏ Cost or selling price. If the item has been recently bought or sold, that can be a
good indicator of its fair market value.
❏ Replacement cost. This may come into play when settling an insurance claim as
well as preparing a tax return. It refers to what it would cost to buy or build a
similar property or asset.
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❏ Expert opinion. When you hire a professional appraiser to give you a value on a
piece of property, the resulting figure will be the fair market value, in this expert’s
opinion. Generally, the weight given to an expert's opinion on matters such as the
authenticity of a coin or a work of art, or the most profitable and best use of a
piece of real estate, depends on the knowledge and competence of the expert
and the thoroughness with which the opinion is supported by experience and
facts. For an expert's opinion to deserve much weight, the facts must support the
opinion.
Calculating the fair market value of your home can be valuable in terms of your
ability to sell your home and understand where improvements to the estimated value
(those that are within your control, at least) can be made. Therefore, it’s important to
understand the value of your home before you decide to sell so that you can make the
appropriate improvements to your home if you want to sell it at a higher price.
2. Taxes
Additionally, it’s valuable to know the fair market value of your home because
municipal property tax is typically based on the FMV of a property. If you have owned
your home for a long time and the FMV has gone up, your taxes might be a lot higher
than they were when you purchased it.
The value of your home can also impact your gift tax, estate tax, tax credit, and
tax deductions after a casualty loss. For example, if you plan to gift your home or
include it in an inheritance, then the person who gets your home will have to pay taxes
on the fair market value of the property. If the person chooses to sell the house and gets
more for it than the value at which it was assessed in the inheritance, then they will
have to pay capital gains tax on the difference between the sales price and the fair
market value.
3. Insurance
Fair market value can impact things like insurance claims made when a property
is damaged. When determining your insurance cost per month, the appraisal will be
used to determine the fair market value of the property. Then, the insurance company
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will take into account any liabilities included in the home to determine the coverage and
cost of the insurance.
For example, if your home is caught in a natural disaster and it has been
evaluated below fair market value, you may not receive the appropriate compensation
for your belongings. Another example is if your car is evaluated below fair market value
and you get hit in an accident, you will not receive adequate reparations from your
insurance company.
Principal Market is the market with the greatest volume and level of activity for the
asset or liability.
Most Advantageous Market is the market that maximizes the amount that would be
received to sell the asset or minimizes the amount that would be paid to transfer the
liability, after taking into account transaction and transportation costs.
A fair value measurement assumes that the transaction takes place in the
principal market for the asset or liability. Only in the absence of a principal market does
the entity assume that the transaction takes place in the most advantageous market.
It was said that the utilization of fair value measurement for financial reporting
presents significant challenges, requiring judgement and interpretation. The regulatory
frameworks continue to change.
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This means that the new valuation methodologies are being created and refined
as they are adopted by market participants. And as the fair value standards dictate, it is
the market participant view that shapes fair value. As a result, preparers of financial
statements cannot be complacent about the methodologies they use to measure fair
value. Management needs to monitor developments in valuation techniques to ensure
that its valuation models appropriately reflect the types of inputs that market participants
would consider.
Although the fair value accounting principles under US GAAP and IFRS are
largely converged, achieving global comparability in measuring fair value is a
continuous challenge in an ever-changing world.
2.) Level 2 inputs- are inputs that are observable either directly or indirectly.
It includes quoted prices for similar assets or liability in an active market and
quoted prices for identical assets or liability in an inactive market.
3.) Level 3 inputs- are unobservable inputs for the asset or liability.
Unobservable inputs are usually developed by the entity using the best available
information from the entity’s own data. Level 3 inputs include the present value of
estimated cash flow.
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References:
https://www.investopedia.com/terms/f/fairmarketvalue.asp#:~:text=The%20fair%20mark
et%20value%20is,time%20to%20make%20the%20decision.
https://globalarbitrationreview.com/guide/the-guide-damages-in-international-arbitration/
3rd-edition/article/overview-of-methodologies-assessing-fair-market-value
https://www.investopedia.com/terms/f/fairmarketvalue.asp
https://corporatefinanceinstitute.com/resources/knowledge/finance/fair-value/?fbclid=Iw
AR3-SksTQ7mBRw5pb96EddxIp-nhlzwzHvyxEa7-SSNB08ZS29wWL4kH95E#:~:text=F
air%20value%20refers%20to%20the,an%20asset%20%E2%80%93%20a%20product%
2C%20stock&text=For%20example%2C%20Company%20A%20sells,shares%20at%20
the%20original%20price
https://www.investopedia.com/terms/m/market-approach.asp
https://corporatefinanceinstitute.com/resources/knowledge/valuation/market
-approach-valuation/?fbclid=IwAR2EJ5G1raObNkiYQiAQYluarfy6vWDylRo
Yku7aLUo9j02cRmFhFXrQXPg
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