Calculation Vs. Conclusion of Value – Which Level of Service is Appropriate in Litigation?
Which level of service is appropriate in litigation?
Business valuation experts generally can be engaged to provide either a “conclusion of value” or a “calculation of value.” While these terms sound similar, there are significant differences between these two types of engagements.
Overview of Professional Standards
Most professional standards that govern the work of business valuation professionals — including the AICPA’s Statement on Standards for Valuation Services VS Section 100 (VS 100) — identify two types of professional service engagements:
1. Valuations. During a valuation, the analyst, in opining on the value of the subject interest, “is free to apply the valuation approaches and methods he or she deems appropriate in the circumstances,” according to VS 100. He or she expresses the results of the valuation as a conclusion of value; it may be either a single amount or a range.
2. Calculations. With a calculation, “the valuation analyst and the client agree on the valuation approaches and methods the valuation analyst will use and the extent of procedures the valuation analyst will perform in the process of calculating the value of a subject interest,” according to VS 100. Like a conclusion of value, the results of a calculated value may be stated as either a single amount or a range.
The professional standards of other valuation organizations, such as the National Association of Certified Valuation Analysts (NACVA) and the American Society of Appraisers (ASA), provide similar guidance.
Limits of Calculations
The development and reporting requirements for a calculation are generally far less stringent than those that apply to valuations. For example, to keep costs down, the parties might agree that the valuation analyst will rely on the capitalization of earnings method and won’t consider any market- or asset-based valuation approaches, which would require a significant amount of work. They might also agree to limit or eliminate certain valuation procedures, such as site visits or management interviews.
A calculated value can be a cost-effective tool under the right circumstances. For example, it might be appropriate in strategic planning, transaction planning or out-of-court settlement negotiations, particularly when the analyst lacks access to the financial information necessary for a full valuation engagement.
However, in a litigation setting, a calculation is rarely appropriate, because it doesn’t result in an opinion of value. Moreover, calculations may be susceptible to manipulation and inaccuracy. For example, the asset-based (or cost) approach to valuation often results in lower values than the income or market approaches. So, a party seeking a lower value might opt for a calculation of value based solely on the asset-based approach.
Similarly, in the COVID-19 environment, certain valuation approaches and methods may be more relevant than others. For example, market-based methods that utilize pre-pandemic transaction data may be less reliable than discounted cash flow or other income-based techniques. A calculation engagement that’s limited to only the market approach would prevent the analyst from using his or her professional judgment to select the most appropriate valuation methods.
That’s not to say that calculations of value are prohibited in litigation. Courts have ruled that calculation reports are admissible. But, given their limited scope, calculations are unlikely to be viewed as credible or persuasive.
A Calculated Risk
Even if calculations of value are admissible, relying on them in litigation is risky because calculated values are inherently less reliable than value conclusions. A calculation report will generally contain cautionary language, indicating that 1) the analyst didn’t perform all the necessary procedures required for a valuation engagement, and 2) the results may have differed if a valuation engagement had been performed. Beware: These admissions may raise a red flag to opposing counsel and discredit the expert’s conclusion in the eyes of the court.
Calculation of Value Admissible in Divorce Case
In Horne-Ballard v. Ballard, a key issue was the value of the wife’s medical practice. The trial court made no findings of fact regarding the practice’s value. However, the $550,000 alimony-in-gross award to the husband implied that the court had relied on a calculation engagement performed by the husband’s expert to estimate the practice’s value.
The husband’s expert arrived at a calculation of value of $2,470,000. The expert testified that she was able to eliminate certain calculations she felt were inappropriate and that “a calculation of value requires less speculation than does an opinion of value.”
Conversely, the wife’s expert conducted a comprehensive valuation and opined that the value of the practice was only $241,000. The expert’s report detailed the additional factors and estimates used to reach that opinion.
At trial and again on appeal, the wife argued that a conclusion of value is “much more exacting” than a calculation of value, and, therefore, a calculation shouldn’t be admissible at trial. The trial court found, and an Alabama appellate court agreed, that her objection went to the expert testimony’s weight and credibility, not its admissibility.
The trial court stated that it would consider the wife’s arguments in determining the weight to give the calculation of value. Therefore, the appellate court declined to substitute its judgment for that of the trial court when deciding whether the expert’s calculation of value should be admitted into evidence.