IFRS 13 Asset Accumulation Method – FAQ | IFRS

IFRS 13 Asset accumulation method

The asset accumulation method and the adjusted net asset method are both generally accepted business valuation methods of the asset-based business valuation approach.

The asset accumulation method is well suited for business and security valuations performed for transaction, taxation, and controversy purposes. All business valuation approaches and methods can indicate the defined value of the subject business entity. IFRS 13 Asset accumulation method

In addition, the asset accumulation method also helps to explain the concluded value—by specifically identifying the value impact of each category of the subject entity assets and liabilities.

This informational content of the asset accumulation method is particularly useful in a transaction, taxation, or controversy context when the particular analysis is used to identify:

  1. which asset categories are contributing how much value to the total entity value;
  2. which asset accounts serve as the collateral for each secured creditor;
  3. which asset accounts are available to serve as collateral for future secured financing;
  4. which asset accounts are available to be sold off from the business entity core operations;
  5. which asset accounts are available to enter into either a lease or a license transaction;
  6. what would be the asset revaluation-related income tax consequences of alternative transaction structures for the sale of the subject entity;
  7. what the opening balance sheet would look like to the acquirer after the sale of the subject entity;
  8. what the value of the subject entity would be under various premise of value scenarios, such as a going-concern valuation versus an orderly liquidation valuation;
  9. what are the values of the individual asset categories contributed by individual investors in the formation of a joint venture or LLP or LLC; and
  10. what was the amount of damages suffered by the individual asset categories of an entity that experienced a tort, a breach of contract, or some other damages event.

Asset Accumulation Method Procedures

Procedurally, the asset accumulation method may be the most difficult business valuation method to perform. However, conceptually, the asset accumulation method may be the most intuitive business valuation method to understand. IFRS 13 Asset accumulation method

The first procedure in the asset accumulation method is the identification of all of the entity’s asset and liability categories. Typically, this procedure starts with the entity’s financial accounting balance sheet.

Some valuation experts prefer to start this valuation procedure with an audited balance sheet. However, this valuation expert preference is not a requirement to perform the asset accumulation method.

All of the entity’s asset and liability accounts are subject to revaluation to the valuation assignment standard of value. Therefore, it is not particularly important if the valuation expert starts with an audited, reviewed, compiled, or internally prepared balance sheet. IFRS 13 Asset accumulation method

Likewise, it is not particularly important whether the balance sheet is prepared in compliance with U.S. GAAP or international GAAP. Again, the reported asset and liability accounts are going to be restated to the intended standard of value. IFRS 13 Asset accumulation method

It is helpful for the valuation expert to start with a balance sheet prepared as close as possible to the assignment valuation date. However, this is a convenience and not a requirement. Sometimes, the valuation expert will simply not have an entity balance sheet available at the beginning of the asset accumulation method analysis.

In that case, the valuation expert has to start with a blank page and independently identify all of the asset categories and liability categories associated with the subject entity.

In this first procedure, the valuation expert identifies all of the entity’s assets. This process includes all of the assets that are already recorded on the entity’s balance sheet. And, this process includes all of the assets that are owned and operated by the entity— but that are not recorded on the entity’s balance sheet.

In particular, most internally created intangible assets will not be recorded on the entity’s balance sheet. Therefore, the valuation expert will have to identify and capitalize (which simply means record) these off-balance sheet intangible assets on the revalued entity balance sheet.

Also in this first procedure, the valuation expert identifies all of the entity’s liabilities. This process includes all of the liabilities that are already recorded on the entity’s balance sheet.

And this process includes all of the liabilities that are either (1) not typically recorded on a balance sheet or (2) created as part of the hypothetical sale transaction.

For example, contingent liabilities are not typically recorded on a balance sheet but would be considered in an asset accumulation method valuation analysis. Also, income taxes related to the hypothetical asset sale and expenses related to the hypothetical entity sale transaction are examples of liabilities that would be created in the valuation process.

The second procedure in the asset accumulation method is to value all of the identified asset and liability accounts. The valuation expert will restate all of the recorded asset and liability accounts to the assignment standard of value. And the valuation expert will record all of the previously unrecorded assets and liabilities at the assignment standard of value.

The valuation expert will consider all of the generally accepted property valuation approaches in this procedure. That is, this analysis will include consideration of all cost approach, market approach, and income approach property valuation methods.

In particular, the valuation expert will ensure that the individual asset and liability accounts are restated to the same standard of value—and to the same premise of value—as was intended for the overall business valuation assignment.

The third procedure in the method is the mathematical subtraction of the total liabilities value from the total asset value. This subtraction indicates the value of the entity’s total equity.

Of course, this value indication can be adjusted:

  1. to conclude the value of the entity’s invested capital (i.e., long-term debt plus total equity) or
  2. to conclude the value of one class of the entity’s equity (e.g., the entity’s voting common stock).

And, the valuation expert should be aware that the asset accumulation method value summary is typically stated as a marketable, controlling ownership interest level of value. To the extent that another level of value is appropriate for the subject business valuation assignment (e.g., a non-marketable, non-controlling level of value), then the valuation expert will assess appropriate valuation adjustments.

The remainder of this discussion focuses on the identification and valuation of an entity’s individual asset and liability accounts.

Current Asset Accounts

Current asset accounts typically include cash, marketable securities, prepaid expenses, accounts receivable, materials and supplies, and inventory.

First, the valuation expert performs whatever due diligence procedures that may be necessary to confirm the existence of these current asset accounts.

Second, the valuation expert restates the asset account balances to a current value as of the assignment valuation date.

For most current asset accounts, the account value does not change materially under alternative standards of value. And for many valuation analyses, the valuation expert often applies a simplifying assumption: that the recorded current asset account balance is representative of the intended standard of value account balance.

Sometimes, if there are material amounts of accounts receivable or inventory balances, then the valuation expert may revalue these accounts. When valuing the accounts receivable balance, the valuation expert may create a contra-asset account (similar to a reserve for uncollectible accounts) to conclude the current value of this asset. In quantifying this reserve (or reduction) account, the valuation expert will consider the following:

  1. The age of the subject receivables
  2. The collectability of the subject receivables

The valuation expert may restate the historical cost of the entity’s inventory account to a current value as of the valuation date. The current inventory value is often reflected by a replacement cost estimation or a FIFO inventory accounting convention for the subject asset.

In addition to estimating the replacement cost for the subject inventory, the valuation expert may consider appropriate contra-asset valuation reserves for inventory shrinkage or inventory obsolescence.

Real Estate and Tangible Personal Property IFRS 13 Asset accumulation method

This category of assets includes two principal subcategories:

  1. Real estate
  2. Tangible personal property

Real estate typically includes land, land improvements, buildings, and building improvements. Tangible personal property includes productive machinery and equipment, tools and dies, computer and office equipment, furniture and fixtures, and vehicles and transportation equipment.

Depending on the age of these assets, there may be a material difference between the historical cost basis asset balances recorded on the entity’s balance sheet and the asset current values as of the assignment valuation date.

And depending on the experience and expertise of the valuation expert, the valuation expert may:

  1. perform the asset revaluation or
  2. rely on property appraisals performed by third-party specialists.

In either case, the value of land and land improvements is often based on the market approach and the sales comparison method. The value of the buildings and building improvements is often based on the cost approach and the depreciated replacement cost method.

Buildings and building improvements may also be valued by reference to the market approach if sales of sufficiently comparable properties are available. However, the use of the cost approach is somewhat more common when applying the asset accumulation method—particularly if the value in continued use premise of value is appropriate.

The value of the machinery, equipment, and other tangible personal property is typically based on the cost approach and the depreciated replacement cost method. The valuation expert may test the replacement cost indications by analyzing recent purchases of sufficiently comparable new equipment items.

It is unlikely that the valuation expert will be able to identify sales of sufficiently comparable portfolios of operating assets. For this reason, the market approach is not often used to value tangible personal property in the asset accumulation method analysis.

It is also uncommon for the valuation expert to be able to associate a specific income stream with the tangible personal property. For that reason, the income approach is not often used to value tangible personal property in the asset accumulation method analysis.

Most of the owned real estate and tangible personal property will be recorded on the entity’s balance sheet. Accordingly, the analysis of this asset category is primarily a valuation analysis instead of an identification analysis.

The valuation expert may investigate whether the entity operates leased tangible personal property in addition to owned tangible personal property. Such leases may be accounted for as operating leases under GAAP. However, for asset accumulation method valuation purposes, the valuation expert may consider capitalizing the value of the entity’s leasehold interest in the equipment.

Throughout the valuation analysis of this asset category, the valuation expert should be mindful to apply a consistent standard of value and a consistent premise of value. And, of course, the asset valuation standard of value and premise of value should be consistent with the standard and premise that is appropriate for the overall subject valuation assignment.

Intangible real property and intangible personal property IFRS 13 Asset accumulation method

The intangible real property category includes the following types of assets:

  1. Real property leases
  2. Easements and rights of way
  3. Air rights, water rights, surface use rights
  4. Mineral, mining, and extraction rights
  5. Building permits and development licenses

Each of these groups of intangible real property can be valued by using various cost approach, market approach, or income approach property valuation methods.

The intangible personal property category includes the following types of assets:

  1. Customer-related intangible assets (e.g., customer contracts, customer relationships)
  2. Contract-related intangible assets (e.g., licenses and permits, supplier contracts)
  3. Employee-related intangible assets (e.g., employment agreements, assembled workforce)
  4. Data-processing-related intangible assets (e.g., computer software, automated databases)
  5. Engineering-related intangible assets (e.g., engineering drawings, product formulations)
  6. Intellectual property intangible assets (e.g., patents, copyrights, trademarks)

Each of these examples of intangible personal property can be valued by using various cost approach, market approach, or income approach property valuation methods.

The effort in this part of the analysis is as much about asset identification as it is about asset valuation. Most categories of intangible real property and intangible personal property are not reported on the entity’s balance sheet. Typically, internally created intangible assets are not recorded on an entity’s balance sheet.

Therefore, the valuation expert first has to identify all of the intangible assets that are owned by the entity. Then, the valuation expert has to value each of the identified categories of intangible real property and intangible personal property.

And, the valuation expert has to consider that the right to use an intangible asset is itself an intangible asset. For example, if a corporate subsidiary has the right to use the parent company’s trademark or computer software or patents, then that subsidiary owns an intangible asset (i.e., the right to use the parent’s intangible asset).

It is common for the valuation expert to apply different valuation methods to value different categories of intangible assets.

For example, computer software, engineering drawings, and the assembled workforce are often valued using the cost approach and the depreciated replacement cost method.

Trademarks, patents, and copyrights are often valued using the market approach and the relief from royalty method.

And, customer relationships, proprietary product formula, and licenses and permits are often valued using the income approach and the multi-period excess earnings method.

Because it is common to use multiple valuation methods, the valuation expert should be careful not to overvalue the intangible asset values. That is, the valuation expert should be careful not to assign the same value increment to more than one intangible asset category. Likewise, the valuation expert should be careful to value all of the entity’s intangible asset categories—and not let any value increment “fall through the crack.”

In the typical asset accumulation method analysis, the valuation expert will use one or more income approach methods to value some of the entity’s intangible assets. Most income approach methods include some type of contributory asset charge procedure.

That procedure helps to avoid the double-counting of intangible asset values.

Similarly, most income approach methods include some type of residual earnings or excess earnings calculation procedure. That procedure helps to avoid the undercounting of intangible asset values.

Intangible Value in the Nature of Goodwill IFRS 13 Asset accumulation method

This category of assets includes the entity’s goodwill and going-concern value. It is relatively easy for the valuation expert to identify the existence of goodwill. If the entity is a going-concern business, it probably owns goodwill. Both the existence of historical financial statements and the existence of financial projections and forecasts are indicia of goodwill.

It is noteworthy that the existence of goodwill does not indicate the value of goodwill. That is, just because an entity owns goodwill, that doesn’t mean that the goodwill has a positive value. An entity’s goodwill can have a positive value, a zero value, or a negative value.

Valuation experts often apply the capitalized excess earnings method to estimate the value of goodwill in the application of the asset accumulation method. The capitalized excess earnings method is particularly applicable in an asset accumulation method analysis. This is because the capitalized excess earnings method relies on the values already assigned by the valuation expert to the entity’s:

  1. current assets, IFRS 13 Asset accumulation method
  2. real estate and tangible personal property, and IFRS 13 Asset accumulation method
  3. intangible real property and intangible personal property. IFRS 13 Asset accumulation method

In the capitalized excess earnings method, the valuation expert assigns a fair rate of return (usually based on the entity’s cost of capital) to all of the entity’s identifiable assets. This calculation indicates the required earnings. The valuation expert compares the entity’s actual earnings (usually measured at the earnings before interest and taxes level) to the entity’s required earnings.

If the actual earnings exceed the required earnings, then the difference (the excess earnings amount) is capitalized as an annuity in perpetuity. This positive annuity value is called goodwill.

If the actual earnings are less than the required earnings, then the difference (the income shortfall) is capitalized as an annuity in perpetuity. This negative annuity value is called economic obsolescence.

This economic obsolescence (or negative goodwill value) is used to reduce the values of the entity’s other identified assets.

Using this particular capitalized excess earnings method application, the valuation expert can use the goodwill value (positive or negative) to avoid overcounting or undercounting asset values in the asset accumulation method.

Other Assets IFRS 13 Asset accumulation method

The other assets category is principally composed of two groups of assets:

  1. Non-current financial assets IFRS 13 Asset accumulation method
  2. Excess or nonoperating assets IFRS 13 Asset accumulation method

The non-current financial assets include such assets as deferred income tax and investments in unconsolidated subsidiaries. The value of the deferred income tax account may change based on the valuation expert’s revaluation of depreciable tangible assets or amortizable intangible assets. The deferred income tax account value may also change based on the entity’s assumed sale transaction structure.

The value of investments in subsidiaries (or in long-term notes receivable or similar investments) will change if the valuation expert revalues the underlying subsidiary entity. The valuation expert may or may not revalue these non-current financial assets depending on their materiality compared to the entity.

The excess or non-operating assets are usually tangible assets that are not being used by the entity. Examples of this asset category include land held for investment purposes, assets of discontinued operations, or assets held for sale.

Regardless of the standard of value and premise of value used in the entity analysis, this asset category is typically valued based on a net-realizable value. That value represents the expected selling price of the asset less the expected costs of disposal. IFRS 13 Asset accumulation method

Current liability accounts IFRS 13 Asset accumulation method

The entity’s current liabilities often include accounts and notes payable, accrued expenses, and income taxes payable. Customer deposits are also recorded as current liabilities if they are expected to be earned during the next year. This account category also includes the current portion of the entity’s long-term debt.

Since these liability accounts are all due in less than one year, there is usually little revaluation involved with the current liability accounts. However, it is common for the valuation expert to include the current portion of non-current liabilities with the long-term debt accounts—and then revalue the entire long-term liabilities balance.

Long-Term Liability Accounts IFRS 13 Asset accumulation method

Long-term liabilities typically include bonds, notes, mortgages, and debentures payable. In the asset accumulation method analysis, the long-term liability accounts are easy for the valuation expert to identify. This is because these liabilities are recorded on the entity’s balance sheet.

Depending on the applicable standard of value in the assignment, these liabilities are often restated to the amount at which the liability could be extinguished as of the valuation date.

The valuation expert may consider various factors in the current value analysis of these long-term liabilities, such as embedded interest rate versus current market interest rate, term to maturity, payment history, prepayment penalties, conversion features, and whether the instrument is callable.

If the current value amounts are materially different from the recorded balances, the valuation expert will substitute the current values of the long-term liability accounts on the entity’s balance sheet.

Contingent liabilities IFRS 13 Asset accumulation method

Unlike long-term liabilities, contingent liabilities are not recorded on the entity’s balance sheet. The existence of contingent liabilities may be disclosed in the footnotes to audited financial statements.

Often, these disclosures tell the valuation expert where to look. However, these disclosures do not tell the valuation expert the value of the contingent liabilities. And, often, the valuation date is not the same as the audited financial statement date.

Therefore, the valuation expert may have to perform a fair amount of due diligence to identify the existence of contingent liabilities. The valuation expert will often interview operations and financial management (and general counsel), if such executives are made available as part of the valuation process.

While there are many types of contingent liabilities, the valuation expert may inquire about employee disputes, litigation claims, contract disputes, taxation audits and other issues, and regulatory agency reviews.

The first step related to contingent liabilities is to identify the liability. The second step is to estimate a value for the liability. The valuation expert can use many different methods to conclude a fair value for these contingencies, including scenario analysis, decision tree analysis, and others.

Ultimately, all of these analyses involve estimating the following:

  1. An amount of the liability payment IFRS 13 Asset accumulation method
  2. The timing of the liability payment IFRS 13 Asset accumulation method
  3. The probability of the liability payment IFRS 13 Asset accumulation method

The present value of the various alternative payout events is an indication of the contingent liability value.

Net asset value summary and value adjustment IFRS 13 Asset accumulation method

The net asset value summary represents the purely mathematical procedure in the asset accumulation method analysis. The valuation expert has used judgment and applied valuation approaches and methods to estimate the value of all of the entity asset accounts.

And, the valuation expert has used judgment and applied valuation approaches and methods to estimate the value of all of the entity liability accounts. At this point in the analysis, the valuation expert only has to subtract the total liability value from the total asset value to conclude the net asset value.

The net asset value is also called the total equity value. It is the total of all of the entity’s equity accounts. So, this total would include both common stock and preferred stock. And, this total would include both voting stock and nonvoting stock.

As mentioned above, this total equity indication is typically concluded on a marketable, controlling ownership interest level of value. If the valuation subject is some ownership interest other than 100 percent of the entity equity, then the valuation expert will have to identify and apply appropriate valuation adjustments.

Such valuation adjustments may include the following:

  1. Discount for lack of control
  2. Discount for lack of marketability

Presumably, any other entity-level valuation adjustments were already considered in the asset-category valuation analyses. Such entity-level valuation adjustments may include key person dependence, key customer dependence, key supplier dependence, and so forth.

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