Depending on the situation, CPAs can utilize two types of engagements to estimate the value of a company. Calculations and valuations are both approved by the American Institute of Certified Public Accountants through their Statement of Standards for Valuation Services No. 1 (SSVS). Calculations are generally cheaper and less time-consuming than valuations. They have their uses — and limitations—which is why they generally aren’t used in litigation situations or in IRS compliance.
How are they different? A valuation requires more procedures than a calculation and results in a conclusion of value. In a valuation, the analyst estimates the value of the asset by applying whichever valuation methods he or she deems appropriate given the circumstances. The conclusion can be expressed in a range or a single amount.
In a calculation, the analyst and client agree on the valuation methods and approaches to be used and the extent of the limited procedures to be performed. It is a less rigorous process than a valuation and results in a less detailed analysis and report. A calculation results in a calculated value. Like a valuation, calculation results can be expressed in a range or a single amount.
When is each used? All things being equal, a valuation is better in most litigation settings and for IRS compliance (see the following), 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 more appropriate for lower-level corporate planning, preliminary or transaction discussion, and mediation or negotiations.
For employee stock ownership plans (ESOPs), the U.S. Department of Labor expects a full valuation rather than a calculation.
In litigation, if a calculation has been done for preliminary planning purposes, it is likely that the valuation analyst will insist on performing a full valuation if the case goes to trial.
What does the IRS say? The IRS and tax courts generally demand a valuation rather than a calculation. However, depending on the jurisdiction, there are cases when the IRS has accepted calculations for estate and gift tax purposes. Note that the agency doesn’t officially confirm this.
Which is right for you? SSVS is nuanced but in many cases doesn’t prohibit analysts from choosing a calculation or a valuation. The right choice largely depends on the purpose of the engagement, the intended use of the analysis, and the audience it is prepared for.
You don’t want to use the wrong value estimate at the wrong time. Contact Dembo Jones’ valuation team and we’ll explain the pros and cons of each — taking into account your business, the need, potential pitfalls, and opportunities.