Will the Real Business Valuation Standards Please Stand Up?
The AICPA's SSVS Compared to USPAP and Other Business Valuation Standards
Valuation standards have been around for decades. IRS Revenue Ruling 59-60, issued in 1959, is considered the seminal work on the valuation of ownership interests in closely held businesses. Despite its age, Ruling 59-60 remains a vital document: It is still legally applicable to federal gift, income and estate tax valuations. More important, the valuation procedures that it outlines continue to serve as the template for business valuation assignments of all types, demonstrating its relevance for the complex business organizations that exist today.
Ruling 59-60’s continuing influence is also evident in the comprehensive business valuation standards that began to appear in the late 1980s. The most important of these was the Uniform Standards of Professional Appraisal Practice (USPAP), issued by the Appraisal Foundation in 1987, followed by standards from professional associations such as the American Society of Appraisers (ASA) in 1992, the Institute of Business Appraisers (IBA) in 1993, and the National Association of Certified Valuation Analysts (NACVA). The first edition of USPAP appeared in 1987, published by the then–newly formed Appraisal Foundation, a non-profit organization established by a group of professional appraiser associations. Drafting the standards began at least a year earlier, through an ad hoc committee. From the beginning, USPAP was intended to apply to appraisers in three disciplines: real estate, personal property, and business valuation. USPAP Standards 9 and 10, which address business valuations, were last updated in 2006. Also in 2006, the IRS issued general business valuation standards, applicable to all IRS employees and to those who provide valuation services or review valuations for the IRS.
These comprehensive business valuation standards have much in common, both in content and terminology, including a common dependence on Revenue Ruling 59- 60. The ruling is structured as a list of eight factors-to-consider in valuations, followed by a discussion of each factor in turn. USPAP Standard Rule 9-4 incorporates, under seven headings, almost verbatim, the eight factors from Revenue Ruling 59-60, and this USPAP Standard Rule has remained essentially unchanged from its first issuance in 1987. The eight factors from Ruling 59-60 also appear in ASA Standard I–iii; IBA Standards section 5.3; and NACVA's Development Standards 3.4; as well as in the IRS Standards (under "Analyzing").
In June 2007, after several years of work, the AICPA issued its Statement on Standards for Valuation Services 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset (SSVS), with the goal of improving the "consistency and quality of practice among AICPA members performing business valuations" (SSVS, Foreword). It is effective for engagements accepted on or after January 1, 2008 (SSVS, para. 68, 79).
One force moving the AICPA to issue a valuation standard has been the increasing importance of intangible assets in businesses, and the related movement toward the reporting of business assets at fair value (SSVS, Foreword). In 1959, when Revenue Ruling 59-60 appeared, the concept of intangible assets being the dominant value generator of an entity was a radical thought. At that time, the book value of assets closely tracked the stock prices of publicly traded companies. Generally speaking, the equity section of a typical New York Stock Exchange–listed company was a good indicator of market value. It is no surprise that consideration of book value is prominent among the eight factors in Revenue Ruling 59-60.
Today little or no relationship generally exists between book value and stock prices. The story of what has happened during the intervening years has been well chronicled. Since the mid-1980s, the spread of computers and the Internet, the globalization of trade, and the deregulation of major industries (see Baruch Lev, Intangibles: Management, Measurement and Reporting, Brookings Institution Press, 2001) have made intangible assets a more important component of value than the hard assets of the industrial age (although intangible assets are generally not quantified on balance sheets). Brands, processes, patents, and a host of knowledge based technologies have become the modern- day value drivers. Their scalability and networking effects are not subject to the limits of diminishing returns associated with physical assets.
This circumstance did not go unnoticed by the AICPA. It has formally recognized the existence of business valuation and embraced it: first in 1996 by establishing the Accredited Business Valuator designation; and in 2007 when the AICPA Consulting Services Executive Committee produced the SSVS.
SSVS and the Other Standards
Whether business valuation professionals need more standards is a reasonable question. Comprehensive standards, reflecting a consistency of approach and terminology, have been in use since 1987. Moreover, the specific requirements for the valuation of intangible assets in financial reporting contexts have been extensively developed by FASB, in SFAS 157, Fair Value Measurements, and other standards. (This article distinguishes between "comprehensive business valuation standards," such as USPAP and SSVS, and definitions of specific standards of value, such as fair value for financial accounting purposes as defined in SFAS 157.) It is reasonable as well to worry, in light of the innovations in form and terminology evident in SSVS relative to USPAP and other earlier standards, that CPAs working in a litigation context will be exposed to aggressive questioning about the differences and apparent discrepancies between the AICPA standards and others that may be espoused by opposing experts.
Such questions are beyond the scope of this article, which focuses on the related issue of implementing SSVS at a time when other comprehensive standards, especially USPAP, have attained considerable authority and are well established in appraisal practice. For reasons developed below, the authors believe that most business valuation professionals who will soon be subject to SSVS are currently performing valuation assignments in compliance with USPAP and will want to continue to do so. To the extent that the two sets of standards are not consistent, this situation creates a problem.
To assess the extent of the problem, the authors considered what the standards themselves indicate about relations between them and what differences appear in their preliminary comparison of SSVS with existing standards, especially USPAP.
Continuing Authority of USPAP
To understand the special authority enjoyed by USPAP, it is useful to return to events of the late 1980s. In 1989, less than two years after the first edition of USPAP, the Federal Institutions Reform, Recovery and Enforcement Act (FIRREA) was enacted in response to the federal savings and loan scandals. It required that real estate appraisals used in connection with federally funded projects be conducted according to generally recognized standards, and specified USPAP in defining what those standards should be. However, FIRREA explicitly required adoption only for real estate appraisals. FIRREA Title IX required that real estate appraisals used in connection with "federally related transactions" be performed in writing, in accordance with uniform standards (section 1101). It also required that these "uniform standards" be "generally accepted appraisal standards as evidenced by the appraisal standards promulgated by the Appraisal Standards Board of the Appraisal Foundation" (section 1110). Thus, the second edition of USPAP, issued in 1990, appeared with at least a partial blessing from Congress.
Later, this congressional recognition of USPAP was extended to business valuation. A section of the Pension Protection Act of 2006 (PPA) sought to address IRS concerns of unreasonable valuations for intangible property, such as patents, used in claiming charitable deductions. Here, Congress required that generally accepted valuation standards be followed in developing fair market values of all tangible and intangible property in connection with non-cash charitable contributions. And although the PPA did not mention it by name, USPAP was cited explicitly in the IRS and U.S. Treasury implementation guidance. According to IRS Notice 2006-96, "Guidance Regarding Appraisal Requirements for Non-Cash Charitable Contributions," section 3.02(2): "[A]n appraisal will be treated as having been conducted in accordance with generally accepted appraisal standards... if, for example, the appraisal is consistent with the substance and principals of the Uniform Standards of Professional Appraisal Practice (USPAP), as developed by the Appraisal Standards Board of the Appraisal Foundation."
In addition to the authority bestowed by federal law and IRS implementation guidance, the USPAP business valuation standards have been recognized in federal courts, and increasingly in state courts as well, as prerequisite to the qualification of a business valuation report. An example is Kohler et al. v. Comm'r (TC Memo 2006-152; July 25, 2006). In the Kohler decision, the judge disregarded the report of the expert who had not "prepared in accordance with all USPAP standards" and had omitted "the customary USPAP certification" regarding compliance with those standards. (For more on the general importance of compliance with standards in expert testimony, see David Laro and Shannon Pratt, Business Valuation and Taxes: Procedure, Law and Perspective, Wiley, 2005.)
A Hierarchy of Standards?
Let us briefly consider how the business valuation standards define their relations with other standards. USPAP is explicit. Its Supplemental Standards Rule states: USPAP provides the common basis for all appraisal practice. Supplemental standards... may be used. An appraiser and client must ascertain whether any such published supplemental standards in addition to USPAP apply to the assignment. Supplemental standards cannot, however, diminish the purpose, intent, or content of the requirements of USPAP. As the Appraisal Standard Board's interpretive comment explains: "The purpose of the Supplemental Standards Rule is to provide a reasonable means to augment USPAP." (It should be noted that the Appraisal Standards Board of the Appraisal Foundation has announced changes in the Supplemental Standards Rule for 2008.) IRS Revenue Ruling 59-60 and USPAP are highly succinct; the latter explicitly represents itself as the minimum standards that must be met. When the professional business valuation organizations issued standards for their members in the wake of USPAP, those standards differed somewhat in how they acknowledged or incorporated these founding documents.
The American Society of Appraisers’ Business Valuation Standards (most recent edition 2005; currently being revised) is in closest accord with the spirit of the "supplemental standards rule" by incorporating USPAP by reference explicitly and by drafting standards explicitly "to clarify [USPAP] and provide additional requirements" (General Preamble II). The NACVA and IBA standards acknowledged, but did not explicitly incorporate, USPAP. The AICPA’s SSVS, however, neither defines its relationship to USPAP nor mentions USPAP, instead letting the valuator decide whether the two sets of standards are compatible.
SSVS does not address the question of its place in the universe of existing standards, except for the following general guidance: "Valuation analysts should be aware of any governmental regulations and other professional standards applicable" (para. 2). In this regard, SSVS resembles the NACVA Professional Standards, which say only: "[M]embers may also find it necessary to consider guidelines and/or other requirements established by other organizations or authorities" (section 5.1). Two questions remain open: Whether SSVS is consistent with other standards, and whether it acknowledges any other standards as constituting superior authority.
This ambiguity may create problems for valuation professionals. If the authors are right in assuming that most appraisers subject to SSVS will want to continue to present their valuation work as being in accordance with USPAP, and SSVS does not explicitly define itself as consistent with or subordinate to USPAP, practitioners must negotiate the potential differences on their own.
Points of Comparison
The general structure of SSVS is not unlike that of preceding standards, in that it includes, after introductory considerations, rules for the development of a business appraisal followed by rules for the written appraisal report.
Paragraphs 1–10 describe the scope of the standard, requiring that all AICPA members "who are engaged to, or as part of another engagement, estimate the value of a business, business ownership interest, security or intangible asset" be governed by SSVS. Exceptions from the statement are also spelled out. The main body of the standard is divided into three parts: "Overall Engagement Considerations," including the definition of the assignment and the consideration of professional competence and independence (paras. 11–20); "Development" of the valuation (paras. 21–46); and "The Valuation Report" (paras. 47–78).
SSVS also contains three appendices: Appendix A, an "Illustrative List of Assumptions and Limiting Conditions," and a Glossary (Appendices B and C). The basic Glossary (B) is adopted from the International Glossary of Business Valuation Terms; the Glossary of Additional Terms (C) includes an entry on "fair value."
Finally, SSVS is augmented by Interpretation 1-01, which provides helpful detail on the engagement circumstances in which SSVS is to apply. This augments the guidance on exceptions, already fairly detailed, from the statement itself (SSVS, paras. 5–10). These are issues of particular concern to accounting professionals, and SSVS is unique among business valuation standards in the attention paid to them.
Within that general structure are several innovations. For example, unlike USPAP and other business valuation standards, SSVS does not use Revenue Ruling 59-60’s eight factors in defining the requirements for the content of a business appraisal assignment and report. That is, an appraisal report that lists and addresses the eight factors may well be consistent with USPAP, but because SSVS does not use the same terminology, the question must be resolved with reference to the requirements as they are set out by the standard.
Conflicts Between Standards
Without considerable experience working under USPAP and SSVS, practitioners will not know where conflicts of substance may arise. What is clear at this point is that practitioners wanting to present work consistent with both sets of standards will have to pay attention to the possibility of such conflicts. As an aid to identifying the differences embedded in the standards of the various valuation organizations, Exhibit 1 shows the various types of reports permitted by each organization’s standards, and Exhibit 2 outlines the minimum requirements for report content across report types.
One small but potentially significant difference between SSVS and USPAP appears early on, in the requirements for defining the standard of value. USPAP is notoriously precise on this point, requiring that the appraiser "state the standard (type) and definition of value and the premise of value and cite the source of the definition" [Standard Rule 10-2(vi)]. SSVS is less strict, requiring only that a report "include information" regarding the standard of value and premise of value (SSVS, para. 52). Thus, a report according to USPAP would be likely to satisfy the SSVS requirement, but whether the reverse is true is not self-evident.
An important set of differences that will certainly require the attention of practitioners involves the required topics in abbreviated reports. SSVS describes written reports of three types: a "Calculation Report," a "Summary Report," and a "Detailed Report" (para. 48). The Calculation Report, as defined, is not properly a valuation report; it does not require a definition of the standard of value and many of the other minimum requirements for a business valuation under USPAP. Therefore, the comparison is straightforward: A Calculation Report is not consistent with USPAP. The same comparison with the Summary Report is more complicated. The Summary Report is recognizable as a form of business valuation report, but it, too, would seem to have minimum content requirements (SSVS, paras. 71–72) that are less demanding than those under USPAP [Standard Rules 9-4 and 10- 2(ix)]. As shown in Exhibit 2, the topics that may be omitted in a Summary Report include, in the company description, the history of the business, economic conditions, industry review, and ownership characteristics; and in the financial review, historical financials. In most circumstances, USPAP would require more, even in a Summary Report format.
In this context, it is important to recognize the fundamental difference in how the different standards characterize abbreviated report types. SSVS notes only that the Summary Report is an "abridged version of the information that would be provided in a detailed report." The 2006 edition of USPAP does not use the term Summary Report, but defines a "Restricted Use Report" with reference to the concept of "restricted utility." This type of report must "state a prominent use restriction that limits use of the report to the client and warns that the appraisers’ opinions and conclusions set forth in the report may not be understood properly without additional information in the appraiser’s work file." To be sure, SSVS also requires disclosure of restrictions on the scope of the valuation analysis (para. 19), but the concept of restricted utility as a basis for determining the type of written valuation report is absent in SSVS.
In sum, whereas SSVS simply defines a Summary Report as an abbreviation, USPAP requires that the scope of the valuation analysis for a Restricted Use Report be defined and justified with reference to the particular special purpose of the report. Because the newly defined SSVS Summary Report format will likely be favored by practitioners in many circumstances, it is important at this juncture that appraisers review their understanding of the minimum requirements for an abbreviated format under USPAP, as well as the language required to justify such an abbreviation.
Another noteworthy difference involves the required appendix to a report, known under USPAP as a "Certification" and under SSVS as a "Representation." As the Kohler judge pointed out, USPAP requires that each appraisal report have a certification by the appraiser. The form is spelled out in Standard Rule 10-3. On the other hand, SSVS, para. 66, states that the report should contain a "Representation," and offers a rather different list of factors from which to choose in drafting it.
Apparently, SSVS uses the term "Representation" because accountants have traditionally used "certification" in a technical sense in connection with the accuracy of financial statements Consequently, the AICPA would not want to imply "certification" of the financial data in a valuation report. CPA appraisers wanting to remain consistent with USPAP and SSVS at the same time will perhaps now adopt a phrase like "Representation in Satisfaction of the USPAP Certification Requirement" in order to be consistent with both standards.
The differences do not end there, however. The USPAP certification requires that the appraiser state that "compensation for completing this assignment is not contingent upon the development or reporting of a predetermined value or direction in value that favors the cause of the client, the amount of the value opinion, the attainment of a stipulated result, or the occurrence of a subsequent event." SSVS, though, requires the business valuation analyst only to state whether there are fee contingencies; that is, that "the analyst’s compensation is fee-based or is contingent on the outcome of the valuation." There is, then, some possibility that a report in conformity with SSVS would not be in conformity with USPAP.
The Devil Is in the Details
In the final analysis, because the intent of SSVS is to follow generally accepted valuation principles, conflict between it and USPAP or other general business valuation standards should be minimal. However, as always, the devil is in the details. At some point, it matters how one says things.
Business valuation standards provide a general template for the construction of valuation reports. This template has, for most appraisers, included the language of USPAP. Changing it, or modifying it to accommodate the newly issued SSVS will require both care and judgment, based on a close familiarity with the standards involved. The appearance of SSVS will cause valuation professionals to read their other business valuation standards more closely in the future.
Martin J. Lieberman, CPA, ABV, ASA, a partner of Weiser LLP, is a member of the CPA Journal Editorial Board and the NYSSCPA’s Business Valuation Committee.