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University Lecturer MARIAN COVLEA PhD Candidate in Financial Management May 14, 2007
It will not be easy, so please pay your full attention to the presentation! Please turn your cell phones on Silent or Mute mode You can ask anything, anytime! Thank you in advance!
You can divide your sheets of note-paper into two vertical halves (columns): The left column for slide contents The right column for additional comments, explanations, examples, synonyms, etc. 2. Be attentive rather than writing word-by-word, these slides are available for free at: http://www.ucdc.info/cd/cd_profil.php?cid=1064
WHAT IS VALUATION? (1)
Valuation is a highly educated mental process aiming to (having as purpose): Setting a value (or a monetary level) on a certain element (asset, liability, equity, company, business) The act of appraisal The estimation or acknowledgement of the worth of something
WHAT IS VALUATION? (2)
Valuation is the process of estimating the market value of a financial asset or liability. Valuations can be done on assets (for example, investments in marketable securities such as stocks, options, business enterprises, or intangible assets such as patents, trademarks, know-how, software, databases, and goodwill) or on liabilities (e.g., bonds issued by a company). Valuations are required in many contexts including investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability, and in litigation.
WHAT IS VALUATION? (3)
Valuation is a technique of the Financial Accounting Method Accounting Valuation is preceeded by: (Business) Analysis and Diagnosis of the element to be valued
What is Value? (1) Value in Economy
Here are some meanings of Value in Economy: Relative worth or importance Monetary or material worth, as in commerce The worth of something in terms of some medium of exchange Equivalent worth in money, material or service Estimated or assigned worth
What is Value? (2) Value in Accounting
Value is a complex notion, including: Intrinsic Value: reflects the objective, hard, visible, tangible, concrete, verifiable part of an asset, a liability, a business or a company. inspires and generates patrimonial valuation methods, based on costs of incorporated factors (labour, energy, materials and information) in the element to be valued.
What is Value? (3) Value in Accounting
Utility Value: represents the extension of user’s want/need fulfillment and satisfaction, it is highly subjective. reflects the subjective, soft, invisible, hardly verifiable or provable part of an asset, a liability, a business or a company. generates non-patrimonial valuation methods, such as Discounted Cash Flow.
What is Value? (4)
The Market Value (as a form of Fair Value) reconciles the two types of value CONCLUSION: Value and Valuation are core subjects and major concerns in Accounting
What is “Valuable”?
considerable monetary worth
considerable use or importance qualities worthy of esteem
Scopes (Purposes) of Valuation
evidence and reporting (“A True and Fair View on Patrimony”) Taxation of Properties Mergers and Acquisitions of companies Sale/Purchase of a Business or parts of it Association / Partnership Contracts (Deeds) Stock Exchange Listing and Transactions Litigations
What do we valuate? (1)
We valuate everything a company owns or owes, and the company as a whole: Assets (tangible and intangible, fixed and current, investments, rights, receivables) Liabilities (debts, payables, obligations, loans) Equity (owners’ shares or capital) Income (revenue, gains/profits/benefits)
What do we valuate? (2)
costs Securities (stocks/shares, bonds, derivatives - options, futures) Businesses Companies Activities Advertising campaigns, etc.
The Necessity of Accounting Valuation
According to IAS/IFRS Framework, a financial statement element (assets, liabilities, equity, income, expenses) should be recognized in the financial statements only if: It is probable that any future economic benefit associated with the item will flow to or from the entity; and: The item has a cost or value that can be measured with reliability.
Valuation and Accounting Policies (1)
Accounting policies are the specific principles, bases, conventions, rules and practices adopted by an entreprise in preparing and presenting financial statements. Accounting policies should be chosen in order to comply with IASs and IFRSs.
Valuation and Accounting Policies (2)
Accounting policies should be developed so that information provided by the financial statements is: Relevant for the decision-making needs of users Reliable: neutral (free from bias), prudent, complete in all material aspects, reflect the economic substance of events and transactions and not merely their legal form, and offer a “True and Fair View” on patrimony, financial results and financial position of the company.
Valuation and Accounting Principles (Conventions)
for reasons of prudence, between book value and present value, the least of the two will be selected Adequacy: valuation methods should be adequate to (consistent with) the nature of the valuated element
BUSINESS VALUATION (“Evaluare economico-financiara”) includes: Accounting Valuation
valuate = a evalua dpdv economic si contabil Valuation (process) = (procesul de) evaluare Valuer = evaluator
Synonyms for “Valuation” (1)
appraise = a evalua, a determina valoarea economica, monetara, etc. Apparaisal = evaluare in economie Appraiser = pretuitor, evaluator: “American Society of Appraisers”
Synonyms for “Valuation” (2)
assess = a aprecia, a estima oficial valoarea unei proprietati in scop de impozitare Assessment = estimare oficiala Assessor = persoana care face evaluari de proprietati in scop de impozitare:
“Scottish Assessors Association”
Synonyms for “Valuation” (3)
estimate = a estima, a aproxima, a evalua global Estimation = estimare, aproximare
Synonyms for “Valuation” (4)
evaluate = a evalua acte, probe in justitie, situatii, etc. Evaluator = evaluator de acte, probe in justitie, situatii, etc. “World Evaluation Service” for academic documents
Synonyms for “Valuation” (5)
approximate = a aproxima = aproximare
Synonyms for “Valuation” (6)
survey = a analiza in amanunt, a inspecta, a expertiza, a evalua (o proprietate) Surveyor = inspector – evaluator: “The Royal Institution of Chartered Surveyors”
Synonyms for “Valuation” (7)
valorize = to maintain the value or the price (of a commodity), especially by subsidies or the government’s purchase at a fixed price. Valo(u)r = boldness or determination in facing danger; worth. Valorous = to be worth.
Synonyms for “Valuation” (8)
is the manual or automatic process of applying prices to purchase and sales orders, based on factors such as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry, shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require more setup and maintenance but may prevent pricing errors.
Synonyms for Valuation (8)
is one of the four p’s of the marketing mix. The other three aspects are product, promotion, and place. It is also a key variable in microeconomic price allocation theory. Price is the only revenue generating element amongst the 4ps,the rest being cost centers.
Norms, Regulations and Good Practice (1):
Accounting Standards (IAS), issued by International Accounting Standards Committee (IASC) until April 2001 International Financial Reporting Standards (IFRS), issued by International Accounting Standards Board (IASB) after April 2001
Norms, Regulations and Good Practice (2):
Valuation Standards (IVS), including Guidelines, issued by International Valuation Committee Best Practices (including Professional Ethics and Deontology) created and developed by big international consultancy companies (“Big Four”, etc.) and promoted by professional bodies as Guidelines and Codes
Norms, Regulations and Good Practice (3):
Tradition (“Rules of Thumb”), especially in Great Britain, United States, Germany and France On this subject, an article is posted and can be downloaded for free from: http://www.ucdc.info/cd/cd_profil.php?cid=1064 as “Metodele rapide de evaluare” OMFP nr. 1.752/2005 (Monitorul Oficial nr. 1.080 / 30.11.2005), completed and updated
Romanian Professional Bodies in Valuation
Nationala a Evaluatorilor din Romania (ANEVAR) Corpul Expertilor Contabili si Contabililor Autorizati din Romania (CECCAR) These professional bodies issue technical norms for valuation and promote good practices, ethics and deontology
Bases for Accounting Valuation - Types of Value (1)
cost or book value: purchase or production cost plus other expenses (freight, installation, provision, non-deductible taxes) Current (present, actual) cost: updated, nowadays historical cost less depreciation or amortization Net realizable (settlement) value: sale price less sale expenses Present (market) value, a variety of Fair Value
Bases for Accounting Valuation - Types of Value (2) – Fair Value
Whenever possible, financial statement elements should be valuated at a Fair Value. Market Value is the most desirable variety of Fair Value:
Fair value, also called fair price, is a concept used in finance and economics, defined as a rational and unbiased estimate of the potential market price of a good, service, or asset, taking into account such factors as: 1. Relative scarcity 2. Perceived utility (economist's term for subjective value based on personal needs) 3. Potential risk/return characteristics (i.e., for a tradable asset) 4. Replacement costs, or costs of close substitutes 5. Production/distribution costs, including a cost of capital
Bases for Accounting Valuation - Types of Value (3) – Active Market
Market Value is the most desirable variety of Fair Value. Market Value is accepted only if all Active Market conditions exist: The items traded in the market are homogeneous; Willing buyers and sellers can normally be found at any time; and: Prices are available to the public.
Bases for Accounting Valuation - Types of Value (4) – Market Value
value is the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion.
Bases for Accounting Valuation - Types of Value (5) – Value Added
added: difference, at each stage of production and trade, between the price of final product and the cost of all factors purchased to make the product. Value added includes: wages, amortization, interest, provisions, taxes and fees, profit.
Value/Cost of Inventories as Input (1)
Cost of inventories comprise: Purchase costs, such as the purchase price (including transportation fee) and import charges Cost of conversion: direct labour and production overheads including variable overheads and fixed overheads allocated at normal production capacity Other costs, such as design and borrowing costs
Value/Cost of Inventories as Input (2)
The cost of inventories exclude: Abnormal amounts of wasted materials, labour and overheads Storage costs, unless they are necessary prior to a further production process Administrative overheads Selling costs
Value/Cost of Inventories as Output (1)
c. d. e.
The cost of inventories that are not ordinarily interchangeable and those produced and segregated for specific projects are assigned by specific identification of their individual costs The cost of other inventories is assigned by using either of the following cost formulas: Weighted Average Cost FIFO: First In – First Out LIFO: Last In – First Out
Value/Cost of Inventories as Output (2)
The following techniques can be used to measure the cost of inventories if the results better approximate cost: Standard Cost: 3. Normal levels of materials, labour and actual capacity should be taken into account 4. The standard cost should be reviewed regularly in order to ensure that it properly approximates actual costs.
Value/Cost of Inventories as Output (3)
Method: 1. Sales value should be reduced by gross margin to calculate cost. 2. Average percentage should be used for each homogeneous group of items. 3. Marked-down prices should be taken into consideration.
Value/Cost of Inventories as Output (4)
Realisation Value (NRV) is the estimated sale price less the estimated cost of completion and costs necessary to make the sale. These estimates are based on the most reliable evidence at the time the estimations are made.
Valuation of Goodwill (1)
= Net Acquisition Value (book value, recognised by the market = Market Value): Aquisition Price of Company less Value of Identifiable Assets Ante-factum (income capitalisation approach) = Discounted Cash Flow (DCF): used only for sale of the business or forecasting purposes, not for bookkeeping.
Valuation of Goodwill (2)
Cash Flow (DCF) Method is derived from the future value formula for calculating the time value of money and compounding returns, or the capacity of a business to create over-profit: FV = PV (1 + k)^n
FV = Future Value, after n years PV = Present Value n = number of years of period considered
Valuation of Goodwill (3)
k = Discount Rate, which includes: 2. Risk-free long-term government bond rate 3. Long-term equity risk premium 4. Small company risk premium (where applicable) 5. Specific company risk premium 6. An additional risk premium based on the appraiser’s judgement of specific company risks
Valuation of Equity
Present Value (NPV): E = A – L (E = Equity, A = Assets, L= Liabilities) It represents the value of a company as a whole, calculated by accountants. Value (at the Stock Exchange, for listed companies).
Value and Price
Value is an opinion of an expert and merely an interval, it is a base for commencement of bids, auctions and/or negotiations. Price is the final and monetary expression of value and it is fix, precise, firmly determined, stipulated in an offer or in a contract as a result of bids / auctions, negotiations, commodity exchange transactions, etc.
Other Methods of Valuation (1)
Value = The estimated amount of money that an asset or company could quickly be sold for, such as if it were to go out of business. If the liquidation value per share for a company is less than the current share price, then it usually means that the company should go out of business (or that the market is misvaluing the stock), although this is uncommon.
Other Methods of Valuation (2)
of Thumb = A rule of thumb is a principle with broad application that is not intended to be strictly accurate or reliable for every situation. It is an easily learned and easily applied procedure for approximately calculating or recalling some value, or for making some determination. It comes from tradition, experience and local market conditions.
Other Methods of Valuation (3)
4 applications of The Rule of Thumb method:
food franchise = 50% of annual sales Heating, ventilation & air conditioning contractors = 2 times annual cash profits Mail order business = 50% of annual sales + inventory M o t e l = $20,000 times number of rooms.
Moments in Accounting Valuation
into Patrimony (investments as owner’s equity, purchase, conversion/production, subsidy) Inventory (periodical complete factual listing / check of patrimony items – assets and liabilities) End of the year, for financial reporting purposes Output/Exit from Patrimony (sale, sponsorship, shareholder withdrawal, etc.)
4. 5. 6. 7.
Price is the unit of measurement for value Any price includes cost and profit of seller Types of prices on the chain of distribution: Manufacturer’s price Whole sale price Retail price Export/Import price A previous price is a cost for the next link.
You may ask any question! Do not be shy!
Thank You, for Your Kind and Understanding Attention!
ACCA (The Association of Chartered Certified Accountants): Preparing Financial Statements – International Stream (Paper 1.1), BPP Publishing, London – UK, 2001; Bannock, Graham; Manser, William: Dicţionar internaţional de finanţe, Editura Universal Dalsi – 2000, Bucureşti, 2000; Boardman, Anthony E.; Greenberg, David H.; Vining, Aidan R.; Weimer, David L.: Analiza Cost – Beneficiu: Concepte şi practică, Editura ARC, Chişinău, Republica Moldova, 2004; Caplan, Suzanne: Finance & Accounting, Adams Media Publishing House, Avon – Massachussetts, USA, 2000; Călin, Oprea; Ristea, Mihai: Bazele contabilităţii, Editura Naţional, Bucureşti, 2001; Collin, P.H.; Jollife, Adrian: Dicţionar de contabilitate englez – român, Editura Universal Dalsi – 2000, Bucureşti, 2000;
International Accounting Standards Board: International Accounting Standards/International Financial Reporting Standards, London – UK, 2007, www.iasb.org; International Valuation Standards Committee: International Valuation Standards, Eighth Edition, London – UK, 2007, www.ivsc.org; Low, Jonathan; Cohen Kalafut, Pam: Invisible Advantage: How Intangibles Are Driving Business Performance, Cap Gemini Ernst & Young, Cambridge – Massachussetts, USA, 2002; Needles Jr., Belverd E.; Anderson, Henry R.; Caldwell, James C.: Principiile de bază ale contabilităţii (ediţia a cincea), Editura ARC, Chişinău, Republica Moldova, 2001; Random House Webster’s College Dictionary, New York - NY, USA, 2003; Siegel, Joel G.; Shim, Jae K.: Dictionary of Accounting Terms, Barron’s Business Guides, Hauppauge – New York, USA, 2005;
Smith Linton, Heather: Business Valuation, Adams Media Publishing House, Avon – Massachussetts, USA, 2004; Traşcă, Margareta: Evaluări contabile patrimoniale, Editura Tribuna Economică, Bucureşti, 1998; Ulrich, Dave; Smallwood, Norm: How Leaders Build Value, John Wiley & Sons, Inc., Hoboken – New Jersey, USA, 2006; Van Greuning, Hennie: Standardele Internaţionale de Raportare Financiară (ediţie bilingvă engleză – română), Editura IRECSON, Bucureşti, 2005.
From the bottom of my heart:
THANK YOU FOR YOUR KIND ATTENTION!
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