This document discusses principles of asset and liability valuation according to GAAP. It defines valuation as estimating worth and notes it can be done for financial assets and liabilities. Several models for valuation are described, including absolute value models like discounted cash flow that determine future cash flows, and relative value models that compare to similar assets. Key principles of GAAP that guide valuation are also summarized, such as the historical cost and revenue recognition principles.
2. Introduction
Valuation is the process of estimating what
something is worth.
The valued items are usually financial assets or
liabilities.
Valuations can be done on
Assets: Items the organization owns that can be
cashed upon. Could be tangible or intangible.
Liabilities: The items with monitory value that are
liable to be paid back.
3. Intangible Assets
Intangible assets are those assets which are not
physical in nature.
An intangible asset can be classified depending on
the specifics of that asset as:
Indefinite
Definite
4. Indefinite and Definite Intangible
Assets
Indefinite Intangible Asset:
A company brand name is considered to be an
indefinite asset, as it stays with the company as
long as the company continues operations.
Definite Intangible Asset:
If a company enters a legal agreement to operate
under another company's patent, with no plans of
extending the agreement, the company brand
would have a limited life and would be classified
as a definite asset.
5. Common Intangible Assets
Intellectual Properties .
Goodwill of the company.
Brand Recognition.
6. Purpose of Valuation
Selling assets.
To know the true position of the organization.
Capital Budgeting
Investment Analysis
Proper Tax Liability
For Litigation
And so on….
7. Some Models For Valuation
Absolute Value models
Relative value models
Option pricing models
Fair value Model
Appraised Value Model
Book Value Model
8. Absolute Value Models
This model determines the present value of an
asset's expected future cash flows.
(What they will be worth in the future)
There are two forms:
1. Multi-period models: Such as discounted cash
flow models
2. Single-period models such as the Gordon model.
These models rely on mathematics rather than
price observation.
9. Gordon’s Model
This Model assumes that the dividends grow at a
constant rate at perpetuity and dividends are paid
at the end of every year.
This model might not seem that practical in real
life.
The formula:
P= _D__
Re–g
10. Discounted Cash Flow
Discounted cash flow (DCF) is a method of
valuing the intrinsic value of a company.
It tries to work out the value today, based on
projections of all of the cash that it could make
available to investors in the future.
It produces the closest thing to an intrinsic stock
value.
FCF= EBIT(1-tax rate)-(Capital Exp-Depreciation)-
Change in Working Capital
11. Relative value Models
This model is a simple model where the value of
the assets are based on the observation of
market prices of similar assets.
12. Option Pricing Models
This model is specifically used for a certain type
of financial assets like:
Warrants
Put/Call Options
Employee Stock Options
Embedded Options (Like Callable Bonds)
13. Fair Value Model
It is used in accordance with US GAAP
Here, fair value is the amount at which the asset
could be bought or sold in a current transaction
other than in a liquidation sale.
This is used for assets carrying value- based on
mark-to-market valuations.
14. Appraised Value Model
Sometimes the assets exchanged don’t have a
fair value determined.
Then the value that has been determined by a
professional appraiser is used.
This model is often used for art, rare collectables,
real estate, antiques and so on
15. Book Value Model
The book value of a fixed asset is its recorded
cost less accumulated depreciation.
An old asset's book value is usually not a valid
indication of the new asset's fair market value.
If a better basis is not available, a firm uses the
book value of old assets
16. What Is GAAP?
GAAP stands for Generally Accepted Accounting
Principle.
GAAP is the common set of accounting
principles, standards and procedures that
companies use to compile their financial
statements.
GAAP are a combination of authoritative
standards (set by policy boards) and simply the
commonly accepted ways of recording and
reporting accounting information.
17. Impacts of GAAP
Ease on Financial Reporting:
Basically, before the implementation of GAAP, the
companies had to prepare different financial
report to comply with the standards of different
countries to attract foreign investors.
Corporate Management Benefits:
There are MNCs who have processes in different
countries which had to prepare financial reports
for the countries it has been working on and one
for the home country. This would be expensive
and time consuming but after the introduction of
GAAP, it became much simpler.
18. Impacts of GAAP
Impact on Investors:
There are foreign investors willing to invest and seeking
opportunities, due to the difficulty of understanding,
which would drive them away. Due to the introduction
of GAAP, the investors have now felt an ease on
understanding the financial reports and able to take
better financial decisions when investing on a foreign
market.
Impact on Stock Market:
The stock market also benefits from GAAP as it allows
the international competition on the trading of stocks
for the markets are following the same rules of
accounting principles and will provide global
investment opportunities.
19. VALUATION- PRINCIPLES OF
GAAP
Historical Cost Principle
Revenue Recognition Principle
Matching Principle
Full Disclosure Principle
20. Historical Cost Principle
This Cost Principle requires companies to
account and report based on acquisition costs
rather than fair market value for most assets and
liabilities.
This principle provides information that is reliable
(removing opportunity to provide potentially
biased market values), but not very relevant.
Therefor there is a trend to use fair values.
21. Revenue Recognition Principle
This Principle holds that companies may not
record revenue until:
1. It is realized or realizable.
2. When it is earned.
The flow of cash does not have any bearing on
the recognition of revenue. This is the essence
of accrual basis accounting.
Conversely, however, losses must be recognized
when their occurrence becomes probable,
whether or not it has actually occurred.
22. Matching Principle
Expenses have to be matched with revenues as
long as it is reasonable.
Expenses are recognized not when the work is
performed and contributes to the revenue.
If no connection with revenue can be established,
cost may be charged as expenses to the current
period.
Depreciation and COGS are good examples of
application of this principle
23. Full Disclosure Principle
Information disclosed should be decided based
on trade-off analysis.
Information disclosed should be enough to make
a judgment while keeping costs reasonable.
Information is presented in the main body of
financial statements, in the notes or as
supplementary information.
24. FASB
FASB stands for Financial Accounting Standards
Board
FASB is the designated organization in the
private sector to establish standards that govern
the preparation of financial reports.