Standards of Value

Theory and Applications

Jay E. Fishman, Shannon P. Pratt, William J. Morrison

• Publisher: Wiley
• Year: 2013
• ISBN:
  9781118238912
• Edition: 2
• Topic: Business
• Subtopic: Accounting
• Index: Business

Expert direction on interpretation and application of standards of value

Written by Jay Fishman, Shannon Pratt, and William Morrison—three renowned valuation practitioners— Standards of Value, Second Edition discusses the interaction between valuation theory and its judicial and regulatory application. This insightful book addresses standards of value (SOV) as applied in four distinct contexts: estate and gift taxation; shareholder dissent and oppression; divorce; and financial reporting. Here, you will discover some of the intricacies of performing services in these venues.

• Features new case law in topics including personal good will and estate and gift tax, and updated to cover the new standards issued since the first edition
• Includes an updated compendium discussing the standards of value by state, new case law covering divorce, personal goodwill, and estate and gift tax, and coverage of newly issues financial standards
• Shows how the Standard of Value sets the appraisal process in motion and includes the combination of a review of court cases with the valuator's perspective
• Addresses the codification of GAAP and updates SOV in individual states

Get Standards of Value, Second Edition and discover the underlying intricacies involved in determining "value."

CHAPTER 1

Common Standards and Premises of Value

COMMON STANDARDS AND PREMISES

In this chapter, we provide a brief introduction to the standards of value that we discuss and analyze throughout this book. The premises and standards discussed in this chapter will be discussed in more detail in the upcoming chapters.

We begin by analyzing the meaning of value itself and why it is necessary to understand the elements of each standard of value. We also introduce two fundamental premises of value: value in exchange and value to the holder. Then we briefly address how these premises of value impact the standard of value and the assumptions that underlie any given standard of value.

Price, Value, and Cost

Oscar Wilde wrote:

What is a cynic? A man who knows the price of everything and the value of nothing.1

Wilde's quote illuminates the relationship between price and value as social concepts, highlighting clearly that the words are not interchangeable. Although not interchangeable, in various reference works, price, value, and cost are all defined with reference to one another.

Price, for example, is defined by Webster's New World Dictionary as “the amount of money, etc., asked or paid for something; cost. 2. Value or worth. 3. The cost, as in life, labor, etc. of obtaining some benefit.”2 Black's Law Dictionary defines price as “the amount of money or other consideration asked for or given in exchange for something else. The cost at which something is bought or sold.”3

Webster's defines cost as “the amount of money, etc. asked or paid for a thing; price”4; Black's defines it as “expense; price. The sum or equivalent expended, paid, or charged for something.”5

While price and cost are transactional concepts, value is a less concrete concept, not necessarily requiring the arrival at a set price between parties in a transaction. Value, in fact, represents a more general concept of worth that may not be easily represented by a transactional price or cost. Value exists in a sale, in an ongoing business, and in liquidation. The main question (and the primary focus of this book) is: By what standard should value be judged? Price certainly can sometimes represent value—one arrived at in an arm's-length transaction. Cost sometimes can as well, insofar as it is the amount of money or compensation required to produce or purchase a product or service.

In his classic work, Valuation of Property, James C. Bonbright writes:

The contrast between “value” and “cost” as fundamental concepts is that the former term refers to the advantage that is expected to result from the ownership of a given object of wealth (or to the market price that this advantage will command), whereas the latter term refers to the sacrifice involved in acquiring this object. This distinction is clear in our minds when we ask whether anything or any desirable human achievement “is worth what it costs”. . . . Cost, then, is the price that must be paid for value.6

Cost can take the form of an outlay of resources or forgoing other opportunities, the so-called opportunity cost. While cost may be incurred in acquiring value, value does not necessarily equate to cost.

Webster's has 13 definitions for value, ranging from “a fair or proper equivalent in money commodities, etc., for something sold or exchanged; fair price” to “that which is desirable or worthy of a scheme for its own sake; a thing or quality having intrinsic worth.”7Black's contains two pages of definitions for value, beginning with its primary general definition: “(1) the significance, desirability, or utility of something.” The second definition is “(2) the monetary worth or price of something; the amount of goods, services, or money that something will command in an exchange.”8

The interrelationship between the terms price, cost, and value and the ambiguities associated with them necessitates clear, internally consistent definitions of these terms.

Defining a Standard of Value

In 1989, the College of Fellows of the American Society of Appraisers published an opinion in which it recognized:

. . . the necessity to identify and define the applicable standard of value as a critical part of any appraisal report or appraisal engagement. It (identifying and defining the applicable standard of value) also recognizes that there legitimately can be different definitions of the same appraisal term and different contexts based either on widely accepted usage or legal definitions through statutes, regulations, case law and/or legally binding documents.9

With regard to business valuation, the College of Fellows asserts that “every appraisal report or engagement should identify the applicable standard of value.”10 In addition, the Uniform Standards of Professional Appraisal Practice mandate identification of the standard of value in every appraisal.11

Whereas stating a standard of value in an appraisal engagement seems like a straightforward concept, different standards may have different meanings in different contexts. Therefore, defining value and adhering to the assumptions inherent in a particular standard of value, especially in connection with a valuation for tax, judicial, or regulatory purposes, often is no easy task.

Bonbright perhaps sets the issue up best when he writes:

At first thought one might suppose the problem with defining value is a fairly simple one—or at all events, that it might be settled once and for all by consensus of those experts who were called upon to pass judgment on property values.12

He continues:

When one reads the conventional value definitions critically, one finds, in the first place, that they themselves contain serious ambiguities, and in the second place, that they invoke concepts of value acceptable only for certain purposes and quite unacceptable for other purposes.13

Bonbright further suggests:

[T]he problem of defining value, for the many practical purposes for which the term is used, is an exceedingly difficult one, deserving quite as much attention as does the technique in proof.14

The standard of value is a definition of the type of value being sought. The premise of value is an assumption as to the actual or hypothetical set of circumstances applicable to the subject valuation. Later in this chapter, we introduce the standards and premises of value that are critical to understanding valuation in the judicial and regulatory context.

Premises of Value

Throughout this book, we discuss two fundamental premises of value: value in exchange and value to the holder. The premise chosen establishes the “value to whom?”

• Value in exchange. Value in exchange is the value of the business or business interest changing hands, in a real or a hypothetical sale. Accordingly, discounts, including those for lack of control and lack of marketability, are considered in order to estimate the value of the property in exchange for cash or cash equivalent. The fair market value standard and, to some extent, the fair value standard fall under the value in exchange premise.
• Value to the holder. The value to the holder premise represents the value of a property that is not being sold but, instead, is being maintained in its present form by its present owner. The property does not necessarily have to be marketable in order to be valuable. We discuss later, however, that the value to the holder may be more or less than the value in exchange. The standard of investment value falls under the premise of value to the holder, as does, in certain cases, fair value.

These two premises represent the theoretical underpinnings of each standard of value. In other words, they represent the framework under which all other assumptions follow.

COMMON STANDARDS OF VALUE

In many situations, the choice of the appropriate standard of val...