ACCO – 40013 VALUATION CONCEPTS AND METHODS

MODULE 1 - Overview of Valuation Techniques

Exercise No. Mod 1-1 (Essay)

In terms of Conceptual Framework of Accounting Standard, many of the businesses, companies, and companies
usually prefer the underlying assumption of Going concern,the going concern basis of accounting is the assumption
in preparing the financial statements that an entity will continue in operation for the foreseeable future and does
not plan to go to liquidation, and will not be forced into liquidation or to curtails its operations. It’s a principle
which assumes that a business will operate for the next operational year. If such an intention or need exists, the
financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed. The going
concern assumption is very important for valuation of assets, as they may require valuation on a break-up basis if
the company will cease trading. The principle of their business requires them to report the assets and liabilities in
the financial statements at its cost not in market price.

Exercise No. Mod 1-2 (Essay)

In a rapidly changing and highly competitive business environment, the income for one accounting period probably
predicts the income of the next period. Generally accepted accounting principles rest on a foundation of historical
cost and measurable evidence provided by a business transactions and events that is, the accrual basis of
accounting. The main reasons why almost most of the businesses use and apply the “Accrual Entity Concept” is
because it flattened out the earnings of the company over time, all revenues and expenses as they are generated
and incurred instead of recording them using the "Cash basis concept, most companies reject the cash basis
concept because it has the tendency to overstate the health of the company, making it look profitable, but in
reality, the company might be unprofitable. The Accrual Entity Concept is also advantageous because it includes
account receivables, these accounts help the company to maintain a more accurate image of their profitability that
are particularly intended for long term periods.

Exercise No. Mod 1-3 (Essay)

An accounting entity is a clearly defined economic unit that isolates the accounting of certain transactions from
other subdivisions or accounting entities. An accounting entity can be a corporation or sole proprietorship as well
as a subsidiary within a corporation. An accounting entity is part of the business entity concept, it is important
because it maintains that the financial transactions and accounting records of the owners and the entities cannot
be mix. A business shall be treated as a separate entity from its owner, it means that the transactions that are
related for the business shall be recorded on the business books itself, the same goes when the transaction is
intended for the personal use of the owner, and in that matters, it is very necessary for sole-proprietorship
businesses to exercise and follow the principle of accounting entity because mixing up the life of the business and
yours can result to an unsuccessful operations and cash-flow. The separation of accounting entities is important
because it helps with proper tax accounting and financial reporting.
 Exercise No. Mod 1-4 (Essay)

B. If I were the investor, the equity valuation method are more preferable, with the help of equity method of
accounting, the investor reports the revenue earned by the company on its income statement, in an amount
proportional to the percentage of its equity investment in other company. Under equity method, the investment’s
value is periodically adjusted to reflect the changes in value due to the investors share in the company’s income or
losses.Equity valuation is a term that refers to all the tools and techniques that I can use as an investor so that I can
find out the true value of the company's equity that I will invest. If I would given a chance to invest, I will look first
at the value of their securities, also called equity or stock that will determine if the risk of my investment are not
that too risky.

Exercise No. Mod 1-5 (Essay)

Based from the information that I collected, the reason why financing of a capital expenditure by using the
Leveraged Buyout (LBO) model is better than financing through Equity alone is because in terms of using a cash
acquisition, the purchase price will be certain and you will not have to dilute ownership of your company. Another
reasons why Leverage Buyout preferred over financing, Leverage buyout can often act to revitalize a mature
company. Also, it can increase management commitment and effort because they have greater equity stake in the
company. In a publicly traded company, managers typically own only a small percentage of the common shares,
and therefore can participate in only a small fraction of the gains resulting from improved managerial
performance.

Sample Problem:

Hadelic Company suffered because of the losses it incurred during the first half of 2018. But the
said company still possessed a valuable assets so it became hot in the eyes of other company that caught their
interest. 666 Company is currently making their decision whether to finance the acquisition using the LBO by
investing 100,000 pesos and borrowing the remaining balance of 400,000 pesos at an interest rate of 5% semi-
annually, or by Equity alone.

In the second half of 2018 operations, 666 Company earns 60,000 from the cash flow of Hadelic Company.

● If finance was done using LBO:

Cash Flow
Earned Php60,000 (12% of Php500,000)
Interest paid (Php32,000) (5% of Php400,000)
Shareholder's equity Php28,000

Return of Investment
Earned Php28,000
Original Investment /Php100,000
Return on equity 28%

● If finance was done using Equity alone:

Earned Php28,000
Original Investment /Php500,000
Return on equity 5.6%