Advanced Ass
Advanced Ass
ACCOUNTING I
Section: 2
Prepared by
NAME ID.NO
1.MOKRIYAW MOKONIN_______________________UGE/18943/12
2. MEKDES MOKONIN_________________________UGE/18916/12
LECTURER: Tamirat.H
(MSC)
GOOD LUCK!!
Contents
CHAPTER 6: Asset valuation for financial reporting.....................................................................................3
6.1 Basic of Valuation..............................................................................................................................3
6.2 Overview of international valuation standards..................................................................................4
6.3 Valuation Approaches and Methods.................................................................................................5
6.3.1 Market Approach.......................................................................................................................5
CAPITALIZATION OF CASH FLOW (CCF) METHOD................................................................6
DISCOUNTED CASH FLOW (DCF) METHOD............................................................................6
6.3.2 Income Approach........................................................................................................................7
6.3.3 Cost Approach............................................................................................................................8
6.4 Valuation report................................................................................................................................8
1. Future Profitability
Future profitability is the only thing that determines the current value. The
price should be based on what a buyer can expect in future earnings, not how
the business performed in the past. Past revenue tells us about business
momentum but we are more focused on what’s left over after all the expenses
of running the business have been paid.
2. Cash Flow
Insurance or financial service businesses don’t have many tangible assets, so
the real value is in the cash flow generated through clients (specifically the
cash flow over and above the cost of running the business).
3. Potential Risk
Simply put, less risk is rewarded with a higher price. The more risk a buyer
must assume, the less they’re willing to pay. The greater the certainty that a
percentage of cash flow comes from recurring cash flow and the sustainability
of recurring cash flow will decrease the risk and increase the valuation price.
4. Objectivity vs Subjectivity
There is a mix of art and science that goes into valuing a book of business.
There’s an objective review of revenue, expenses but then there’s the
subjective view on understanding what might make one book more valuable
than another (even if they generate the same revenue). The subjective side
might include looking at the deal itself; terms of payment, guarantees, claw-
back clauses and the seller’s involvement in the transition.
he’s described and defined below are the main approaches used in valuation. They are all based
on the economic principles of price equilibrium, anticipation of benefits or substitution.
Valuation Approaches and Methods may be applied to the valuation of businesses and business
interests.
When selecting an approach and method, in addition to the requirements of this standard, a
value must follow the requirements of IVS Valuation Approaches and Methods, including
The income approach is often used as the primary approach in the valuation of
operating companies. The two most frequently utilized methods of the income approach
are as follows:
CAPITALIZATION OF CASH FLOW (CCF) METHOD
The CCF method is a single period valuation model that converts a company’s benefit
stream into value by dividing it by a rate of return that is adjusted for growth
(capitalization rate). This method is used when the company expects long-term, stable
cash flows into perpetuity. When this method is used, the valuator uses the recent
historical results of the company as a proxy for future operations.
The DCF method is a multiple period valuation model that converts a future series of
benefit streams into value by discounting them to present value at a rate of return that
reflects the risk inherent in the benefit stream. This method is based on the theory that
the value of a company is equal to the present value of its projected future benefits over
a specific period of time, plus the present value of a residual value. In order to execute
this method, the valuator uses forecasts or projections for the company (which are
typically provided by management). If you believe your historical results do not capture
the anticipated growth of your business, this method would be useful to determine the
company’s value.
When the comparable transactions considered involve the subject asset, this method is
sometimes referred to as the prior transactions method.
If few recent transactions have occurred, the value may consider the prices of identical or
similar assets that are listed or offered for sale, provided the relevance of this information is
clearly established, critically analyzed and documented. This is sometimes referred to as the
comparable listings method and should not be used as the sole indication of value but can be
appropriate for consideration together with other methods. When considering listings or offers
to buy or sell, the weight afforded to the listings/ offer price should co\nsider the level of
commitment inherent in the price and how long the listing/offer has been on the market. For
example, an offer that represents a binding commitment to purchase or sell an asset at a given
price may be given more weight than a quoted price without such a binding commitment.
A subset of the comparable transactions method is matrix pricing, which is principally used to
value some types of financial instruments, such as debt securities, without relying exclusively
on quoted prices for the specific securities, but rather relying on the securities’ relationship to
other benchmark quoted securities and their attributes
identify the units of comparison that are used by participants in the relevant market,
identify the relevant comparable transactions and calculate the key valuation metrics for
those transactions,
perform a consistent comparative analysis of qualitative and quantitative similarities and
differences between the comparable assets and the subject asset,
make necessary adjustments, if any, to the valuation metrics to reflect differences between
the subject asset and the comparable assets
apply the adjusted valuation metrics to the subject asset, and
if multiple valuation metrics were used, reconcile the indications of value.
A value should analyze and make adjustments for any material differences between the
comparable transactions and the subject asset. Examples of common differences that could
warrant adjustments may include, but are not limited to:
The income approach provides an indication of value by converting future cash flow to a single current
value. Under the income approach, the value of an asset is determined by reference to the value of
income, cash flow or cost savings generated by the asset.
The income approach should be applied and afforded significant weight under the following
circumstances:
the income-producing ability of the asset is the critical element affecting value from a
participant perspective, and/or
Reasonable projections of the amount and timing of future income are available for the subject
asset, but there are few, if any, relevant market comparable.
A fundamental basis for the income approach is that investors expect to receive a return on their
investments and that such a return should reflect the perceived level of risk in the investment.
Cost approach valuation applies the assumption that a property’s fair value can
be equated to the cost of building a similar property. The costs involved would
include the value of the underlying land and improvements to it. Cost approach
method also factors in the depreciation on these improvements and deducts it
from the overall value of the property to arrive at a more realistic price.
The cost approach provides an indication of value using the economic principle that a buyer will
pay no more for an asset than the cost to obtain an asset of equal utility, whether by purchase
or by construction, unless undue time, inconvenience, risk or other factors are involved. The
approach provides an indication of value by calculating the current replacement or
reproduction cost of an asset and making deductions for physical deterioration and all other
relevant forms of obsolescence.
replacement cost method: a method that indicates value by calculating the cost of a
similar asset offering equivalent utility,
reproduction cost method: a method under the cost that indicates value by calculating
the cost to recreating a replica of an asset, and
summation method: a method that calculates the value of an asset by the addition of
the separate values of its component parts.
The property valuation report includes property information – rates, size of the land and
building, physical details on the construction and condition of the dwelling, details on
any immediate issues that may need addressing – as well as information on
comparative sales in the area.