There’s an interesting debate among valuation circles regarding valuations versus calculations and whether calculations are ever appropriate.
For most valuation professionals, the answer is a resounding yes—there is a place for calculations in the valuation world. However, calculations must be used properly because calculations and valuations are not equal.
For those unfamiliar with the differences between the two types of engagements—calculations and valuations—some background helps frame the debate. The American Institute of Certified Public Accountants (AICPA) is the national professional association of CPAs in the US. All CPAs must follow AICPA guidelines when it comes to how they practice.
In terms of valuations, CPAs follow the AICPA’s Statement of Standards for Valuation Services No. 1 (SSVS), which was issued in 2007 and covers a broad range of topics, from professional competency to objectivity. SSVS also clearly describes the two types of valuation engagements CPAs can perform to estimate value—calculations and valuations.
According to the AICPA, a “valuation engagement requires more procedures than does the calculation engagement. The valuation engagement results in a conclusion of value. The calculation engagement results in a calculated value. The type of engagement is established in the understanding with the client.”
Further, SSVS says that in a valuation engagement, “the valuation analyst estimates the value of a subject interest and is free to apply the valuation and methods he or she deems appropriate in the circumstances.” The conclusion of value may be either a single amount or a range.
Regarding a calculation engagement, the “analyst and the client agree on the valuation methods and approaches the valuation analyst will use and the extent of the procedures the valuation analysts will perform …” Like a valuation, the calculated value may be either a single amount or a range.
By definition, the outcomes of a valuation and a calculation are different and are typically used for different purposes.
The recent controversy over the use of calculations was prompted by an article written by Michael Paschall of Banister Financial in Charlotte, NC entitled “Breaking Bad in the Business Valuation Profession.” Paschall’s thesis is that calculation engagements “compromise the standards of reliability and independence,” and that most “nonappraisers do not understand the unreliability of a calculation as compared to a real valuation and may treat the two as equals.”
Paschall’s main points are that calculations are incomplete and highly limited, that they are inherently biased because the client is involved in selecting the methodology and approach, and that they are easily confused with a “real” valuation. He also suggests that they are easier and far more profitable than full valuations and that’s why CPAs tend to offer them.
In response to Paschall’s article, several highly regarded valuation professionals—James Alerding, Edward Dupke, and James Hitchner—put forth their own argument in an article entitled, “Calculation Engagements: The REAL Story.” In this piece, the three authors defend and clarify the use of calculations by valuation analysts and address Paschall’s position point by point.
The overriding message in the Alerding, Dupke, and Hitchner article is that calculations can be reliable, detailed, and complete. “Cost is usually the main reason that calculations are used,” the authors state. “Depending on the amount of work performed, the scope of services, the intended use and the intended users, a calculated value can be sufficient, reliable [and] believable …”
They continue, “All valuation services are real, and valuation analysts are not making more money doing calculations.”
It should be noted that Paschall is not a CPA, although he holds the ABV valuation credential from the AICPA, as well as valuation credentials from other recognized and respected valuation credentialing organizations. Alerding, Dupke, and Hitchner are CPAs and, like Paschall, hold the ABV credential from the AICPA, as well as valuation credentials from other recognized and respected valuation credentialing organizations.
A Case in Point
An interesting adjunct to this controversy—one with especially good timing—is the case of Rohling v. Rohling, a divorce case originally decided by a trial court in April 2017 and then addressed by the Alabama Court of Appeals in July 2018.
This case involved Dr. Robert Rohling, a dentist, and his wife, Lylie Rohling. Among other issues, the parties disagreed about the valuation of the husband’s dental lab. The wife hired a valuation-certified CPA for a calculation engagement, while the husband served as his own valuation expert.
The husband’s team attacked the CPA’s work, claiming that, among other errors, he had conducted the “wrong” type of valuation and should have done a more “thorough and accurate” valuation versus a calculation.
The trial court disagreed and found that the expert used “methods recognized and accepted” by the accounting profession and that it didn’t matter that a “more arduous” valuation option existed. The court also pointed out that the husband’s team didn’t actually contradict the CPA’s findings, nor did his team hire its own expert to perform a more thorough valuation. The court found for the wife.
The appeals court agreed, saying that the CPA conducted the calculation according to SSVS standards and that the husband had offered no contradictory evidence relative to the calculated value that the wife’s expert presented.
While using a calculation in a high-stakes divorce case like this one is unusual, the work held up in court as a legitimate assessment of value.
When Calculation Works Best
As suggested previously, the bottom line on valuation versus calculation comes down to the purpose of the engagement, its intended use, and intended users.
All things being equal, a full valuation is better in most litigation settings and for IRS compliance, financial reporting, and specific types of corporate planning. Because a calculation is limited in scope and includes only approaches and methodologies to which the client agrees, it is generally most appropriate for lower-level corporate planning, preliminary or transaction discussions, and mediation or negotiations.
There are many nuances to valuation work, so it is imperative that clients discuss the type of assessment necessary to meet the goals of the engagement with a valuation professional. He or she can serve as a guide in discerning which type of engagement is more appropriate for the circumstances.