This case puts the student in the role of a CPA, ABV engaged in valuing a closely held family business for purposes of buying out a disenfranchised family member. Students are exposed to basic valuation research, confront the limitations of historical cost financial statements, choose an appropriate valuation method and exercise professional judgment in a variety of valuation decisions. The issues of objectivity, client conflicts of interest and business valuation accreditation are also introduced.
The case is appropriate for junior or senior level accounting or finance majors with a solid background in financial accounting. The case can be taught in one to two hours of class time and will require four to five hours of outside preparation by students.
Jess Parker, a CPA, ABV, is hired by one his former college friends to place a value on a wholesale grocery business currently owned by him, his brother and sister. Family friction has led to the brother wanting to retire and have his interest bought by the other two siblings.
Over a three week period, Jess works with his client and one of his staff members in doing the research and preliminary work. As he responds to questions from the client and his assistant, Jess explains some of the major challenges and issues involved in valuing a non-public business. Students research some common valuation methods and select the one most appropriate to the set of conditions in the grocery valuation. As students progress through the valuation and write the report they deal with limitations of traditional financial reports, the challenge of estimating proper discount and capitalization rates and the subjectivity of the valuation process.
[Data for the case is adapted from the AICP A's Course: "Developing Your Business Valuation Skills: An Engagement Approach". Copyright American Institute of Certified Public Accountants. Used with permission. All rights reserved.]
DISCUSSION ITEM 1
Traditional GAAP -based financial statements should reflect full-accrual, primarily historical cost-based values. (Although not legally required to do so, many closely-held companies also prepare GAAP -based statements at the request of creditors.) While appropriate for the general investor and creditor trying to evaluate the firm's future earnings and cash flows, many GAAP-based amounts may not be relevant for valuation purposes. Among the reasons why GAAP standards are not always compatible with fair- value decisions are that 1) assets are reported at depreciated book value (using historical cost) and not at replacement cost or fair value; 2) revenue recognition rules may not be consistent with GAAP; 3) accounting estimates (e.g. bad debt reserves, depreciation lives, warranty provisions, pension accruals) may be overly optimistic or overly cautious;
DISCUSSION ITEM 2
The objective for this activity is for students to become familiar with some basic business valuation methods available to practitioners and discover some of the variables involved in the valuation process. Students will give a wide variety of responses depending on which particular sources are used. Students that limit their research to only those references in Appendix IV could adequately respond to Item 1 in an hour or so. Students using other resources might take an additional hour to complete this question. The following summaries are based on the sources in Appendix IV of the case that are typical of most discussions of valuation methods. It's important that students describe not only the calculation procedures but also that they have at least some appreciation of when each method is most appropriate.
Capitalized earnings approach: This is one of the most commonly used methods. It is appropriate when current earnings are presumed to be a good estimate of future earnings and will continue indefinitely. …