FAS 105, 107, 115, 130, 133, 141, 142, 155, 157, 159
Bob Jensen
Emeritus Professor of Accounting
Trinity University in San Antonio
190 Sunset Hill Road
Sugar Hill, NH 03586
603-823-8482
rjensen@trinity.edu
http://www.trinity.edu/rjensen/
“Not everything that can be counted, counts. And not everything that counts can be counted.”
Albert Einstein
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Bill Belichick School of forecasting
■ A former assistant under Bill Belichick, Mangini arrived in New York last
year with an insider's knowledge of the Patriots' sign-stealing surveillance
tactics and he shared the dirty little secret with members of the Jets'
organization, a person with knowledge of the matter informed the Daily
News yesterday.
■ It wasn't until the fifth Mangini-Belichick showdown - last Sunday - that
the Jets were able to catch the Patriots. Tipped off by Jets security, an
NFL security official confiscated a video camera and tape from a Patriots
employee at the Meadowlands, and the evidence is believed to be damning
Rich Cimini, "Eric Mangini exposes Bill Belichick's spy games," NY Daily
News, September 12, 2007 --- Click Here
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Alternative Accounting Measures of Value
of Assets and Liabilities
“Skate to where the puck is going, not to where it is.”
Wayne Gretsky (as quoted for many years by Jerry Trites )
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Alternative Accounting Measures of Value
of Assets and Liabilities
“Skate to where the puck is going, not to where it is.”
Wayne Gretsky (as quoted for many years by Jerry Trites )
1-4
Alternative Accounting Measures of Value
of Assets and Liabilities
Skate to where the puck is going, not to where it is.
Wayne Gretsky (as quoted for many years by Jerry Trites )
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FAS 33 from 1979-1984 (ended with FAS 82)
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Knotted Strings
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Origins of Double Entry
Accounting are Unknown
■ 1300s A.D. crusades opened the Middle East and Mediterranean trade routes
■ Venice and Genoa became venture trading centers for commerce
■ 1296 A.D. Fini Ledgers in Florence
■ 1340 City of Massri Treasurers Accounts are in Double Entry form.
■ 1494 Luca Pacioli's Summa de Arithmetica Geometria Proportionalita (A
Review of Arithmetic, Geometry and Proportions)
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Going Concern and Accrual Accounting
Evolved in the 1500s
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Limited liability Corporations
(divorced professional management
from ownership shares)
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Speculation Fever and Stewardship
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Laissez-Faire Accounting survived endless
debates and scandals until the Great
Depression in 1933
■ Much of the debate focused on capital maintenance (e.g., failure to charge off depreciation and
failure to provide for replacement of operating assets), but governments did not legally impose
auditing requirements and serious GAAP until the U.S. securities laws in the early 1930s.
Accountants were vocal in reform movements, but governments were slow to react with
legislation and courts failed to establish consistent GAAP.
■ Creation of the SEC in an effort to regain public trust in financial reporting and equity
investing.
■ Many firms did have independent audits and conformed to the best GAAP traditions of the day
(thereby giving some evidence that Agency Theory works sometimes.) Agency theory
hypothesizes that it is in the best interest of management to contract for protection of investors
and avoid scandalous asymmetries of information.
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After 1933, the AICPA and the SEC seriously attempted to
generate accounting standards, enforce accounting standards,
and provide academic justification for promulgated standards.
■ ASRs of the SEC
■ In a 3-2 vote the SEC followed George O. May's efforts to mandate external audits of
securities traded across state lines in the U.S.
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After 1933, the AICPA and the SEC seriously attempted to
generate accounting standards, enforce accounting standards,
and provide academic justification for promulgated standards.
■ 1960-1972 A.D.: Accounting standards in the U.S. were generated by the AICPA's Accounting Principles Board
(APB) that had more members than the CAP and a mandate to attack more controversial reporting issues. The APB
attacked some controversial issues but often failed to resolve their own disputes on such issues as pooling versus
purchase accounting for mergers.
■ 1972-???? A.D. Accounting standards in the U.S. were, and still are, being generated by the Financial Accounting
Standards Board (FASB) that has seven members, including required members from industry, academe, and financial
analysts in addition to members from public accountancy. FASB members must divorce themselves from previous
income ties and work full time for the FASB. The formation of the FASB was a desperation move by CPA's to stave
off threatened takeover of accounting standards by the Federal Government (there were the Moss and Metcalf bills to
do just that under pending legislation in the U.S. House and Senate). Unlike the CAP and APB, the FASB has a full-
time research staff and has issued highly controversial standards forcing firms to abide by pension accounting rules,
capitalization of many leases, and booking of many previous OBSF items (capital leases, pensions, post-employment
benefits, income tax accounting, derivative financial instruments, pooling accounting, etc.). The road has been long
and hard on some other issues where attempts to issue new standards (e.g., expensing of dry holes in oil and gas
accounting and booking of employee stock options) have been thwarted by highly-publicized political pressuring by
corporations.
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In 2007 International Harmonization
is Becoming a Reality
■ In Year 2008 foreign corporations may file reports with the SEC
and be listed on U.S. stock exchanges using IASB standards
rather than FASB standards without reconciling the two.
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Fair Value Accounting Under the IASB & FASB
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Fair Value Accounting Under the IASB & FASB
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Fair Value Accounting Under the IASB & FASB
■ Much of the volatilty washes out over time such that earnings
increases and decreases from fair value adjustments have zero
effect on cash in most instances. This is misleading for going
concerns.
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Fair Value Accounting Under the IASB & FASB
■ Ahmed, Kilic, and Lobo (The Accounting Review, 2006, pp. 567-
588) found that fair value booking of derivatives after FAS 133
was far more important than mere disclosures in footnotes for
banking financial statements.
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Fair Valuing Debt
Better/Worse Credit Standing = Loss/Gain
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Fair Valuing Debt
Better/Worse Credit Standing = Loss/Gain
■ Actually there is potential gain from buying back debt
cheaper due to lowered credit rating.
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Fair Value Accounting Under the IASB & FASB
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Key FASB Standards on Fair Value Acctg.
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FAS 107 effective in 1993
Disclosure of Fair Value of Fin. Instruments
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FAS 130 effective in 1998
Reporting Other Comprehensive Income (OCI)
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FAS 133 effective in 2000
Amended by FAS 137, 138, 149, 155, and 159
Accounting for Derivative Financial Instruments and Hedging Activities
■ Financial Derivatives & Scandals Explode in the Early 1990's
■ Video or Audio clip from CBS Sixty Minutes SIXTY01.avi or SIXTY01.mp3
■ Audio clip from John Smith of Deloitte & Touche in August 1994
SMITH01.mp3
■ Examples of derivative contracts that even the professional analysts could not
decipher
● The derivatives that Merrill Lynch wrote that drive Orange County into
bankruptcy
● Other derivatives fraud summaries are at http://
www.trinity.edu/rjensen/fraud.htm#DerivativesFraud
■ Video and audio clips of FASB updates on FAS 133
● Audio 1 --- Dennis Beresford in 1994 in New York City BERES01.mp3
● Audio 2 --- Dennis Beresford in 1995 in Orlando BERES02.mp3
■ Derivative Financial Instrument Frauds --- Off line --- Click Here
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FAS 133 effective in 2000
Amended by FAS 137, 138, 149, 155, and 159
Accounting for Derivative Financial Instruments and Hedging Activities
Purchased Options | Written Options | Long Forwards | Short Forwards | Swaps | Futures Contracts
European versus American versus Asian options
Spot Price, Forward Price, Strike Price, Premium, Intrinsic Value, Time Value
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FAS 141 effective in 2001
Purchase Method Req. for Business Combinations
■ In contrast to Opinion 16, which required separate recognition of intangible assets that can be
identified and named, this Statement requires that they be recognized as assets apart from
goodwill if they meet one of two criteria—the contractual-legal criterion or the separability
criterion. To assist in identifying acquired intangible assets, this Statement also provides an
illustrative list of intangible assets that meet either of those criteria.
■ In addition to the disclosure requirements in Opinion 16, this Statement requires disclosure of
the primary reasons for a business combination and the allocation of the purchase price paid to
the assets acquired and liabilities assumed by major balance sheet caption. When the amounts
of goodwill and intangible assets acquired are significant in relation to the purchase price paid,
disclosure of other information about those assets is required, such as the amount of goodwill
by reportable segment and the amount of the purchase price assigned to each major intangible
asset class.
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FAS 142 effective in 2001
Goodwill and Other Intangible Assets Acquired
■ Purchased goodwill and other intangibles in business combinations are to be
revalued each reporting date and written down to the extent that its historical
cost valuation has been impaired. The historical cost is no longer to be
amortized except in the case of intangibles with finite lives. In theory the cost of
purchased intangibles could stay on the books for many, many years.
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FAS 155 effective in 2006
Accounting for Certain Hybrid Financial Instruments
■ Permits fair value re-measurement for any hybrid financial instrument that
contains an embedded derivative that otherwise would require bifurcation
■ Clarifies which interest-only strips and principal-only strips are not subject to
the requirements of Statement 133
■ Establishes a requirement to evaluate interests in securitized financial assets to
identify interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation
■ Clarifies that concentrations of credit risk in the form of subordination are not
embedded derivatives
■ Amends Statement 140 to eliminate the prohibition on a qualifying special-
purpose entity from holding a derivative financial instrument that pertains to a
beneficial interest other than another derivative financial instrument.
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FAS 155
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FAS 155
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FAS 155
Bifurcate
earnings? derivative if it Host contract?
(Par 12b) was freestanding? (Par 12a)
(Par 12c)
Yes No Yes
Do Not Bifurcate
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FAS 155
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FAS 157 effective in 2006
Fair Value Measurements
The changes to current practice resulting from the
application of this Statement relate to
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Differences Between Statement 157 and
Current Practice
Issue Current Practice Statement 157
Definition Various definitions of fair value – Amount at Price that would be received for an asset
which an asset or liability could be bought or or paid to transfer a liability between
sold in a current transaction between willing market participants at the measurement
parties, that is, other than in a forced date.
liquidation sale
Transaction Entry Price Presumed equal to fair value May not be representative of fair value;
provides indicators of when the
transaction price may not be fair value.
Highest and Best Use Current practice is to value assets in Independent of the reporting entity’s
continued use unless identified for disposition intent: considered from market
participant perspective
Use of Market Data in Valuations Use of market data encouraged. In some Valuation techniques must maximize use
circumstances entity intent permitted to be of market observable data and minimize
considered in valuations. use of unobservable data
Block Discounts Broker-dealers and investment Eliminated for all companies in relation to
companies permitted to apply actively traded securities
block discounts
Restricted Securities Restrictions on marketable Fair value measurement should include the
securities not required to be effect of a restriction, if the restriction is an
considered in the valuation if attribute of the security which would pass to
the restriction terminated within market participants.
one year.
Fair Value
Hierarchy
Level 3
Level 1 Level 2 Income/FCF
Market- based Extrapolate Model
Objective Subjective
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FAS 157
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FAS 157
c. Inputs other than quoted prices that are observable for the asset or liability
(for example, interest rates and yield curves observable at commonly quoted
intervals, volatilities, prepayment speeds, loss severities, credit risks, and
default rates)
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FAS 157
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FAS 157
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FAS 157
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FAS 157
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FAS 157
Level 3 Examples
a. Bonds of a bankrupt firm
b. Asset retirement obligation
c. Pollution abatement obligation
d. Enron’s booking of “fair value” of gas contracts
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FAS 157
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FAS 157
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FAS 157-a
Application of FASB Statement No. 157
to FASB Statement No. 13
Objective
■ 1. This FASB Staff Position (FSP) amends FASB Statement No. 157, Fair
Value Measurements, to exclude FASB Statement No. 13, Accounting for
Leases, and its related interpretive accounting pronouncements that address
leasing transactions.
Background
■ 2. The Exposure Draft preceding Statement 157 proposed a scope exception for
Statement 13 and other accounting pronouncements that require fair value
measurements for leasing transactions. At that time, the Board was concerned
that applying the fair value measurement objective in the Exposure Draft to
leasing transactions could have unintended consequences, requiring
reconsideration of aspects of lease accounting that were beyond the scope of
the Exposure Draft.
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FAS 157-a
Application of FASB Statement No. 157
to FASB Statement No. 13
■ 3. However, respondents to the Exposure Draft indicated that the
fair value measurement objective for leasing transactions was
generally consistent with the fair value measurement objective
proposed by the Exposure Draft. Others in the leasing industry
subsequently affirmed that view. Based on that input, the Board
decided to include lease accounting pronouncements in the scope
of Statement 157.
■ 4. Subsequent to the issuance of Statement 157, which changed in
some respects from the Exposure Draft, constituents have raised
issues stemming from the interaction
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FAS 157-a
Application of FASB Statement No. 157
to FASB Statement No. 13
■ Proposed FSP on Statement 157 (FSP FAS 157-a) 1 FSP FAS 157-a between
the fair value measurement objective in Statement 13 and the fair value
measurement objective in Statement 157.
■ 5. Constituents have noted that paragraph 5(c)(ii) of Statement 13 provides an
example of the determination of fair value (an exit price) through the use of a
transaction price (an entry price). Constituents also have raised issues about
the application of the fair value measurement objective in Statement 157 to
estimated residual values of leased property. These issues, as well as other
issues related to the interaction between Statement 13 and Statement 157,
would result in a change in lease accounting that requires considerations of
lease classification criteria and measurements in leasing transactions that are
beyond the scope of Statement 157 (for example, a change in lease classification
for leases that would otherwise be accounted for as direct financing leases).
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FAS 157-a
Application of FASB Statement No. 157
to FASB Statement No. 13
6. The Board acknowledges that the term fair value will be left in
Statement 13 although it is defined differently than in Statement
157; however, the Board believes that lease accounting provisions
and the longstanding valuation practices common within the
leasing industry should not be changed by Statement 157 without
a comprehensive reconsideration of the accounting for leasing
transactions. The Board has on its agenda a project to
comprehensively reconsider the guidance in Statement 13
together with its subsequent amendments and interpretations.
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FAS 159 effective in 2008
The Fair Value Option for Financial Assets and Financial Liabilities
■ Irrevocable
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FAS 159 effective in 2008
The Fair Value Option for Financial Assets and Financial Liabilities
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FAS 159 effective in 2008
The Fair Value Option for Financial Assets and Financial Liabilities
Scope:
• Recognized financial assets and liabilities (but not forecasted transactions under FAS 133)
• Firm commitments that would otherwise not be recognized at inception and that involve only
financial instruments
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FAS 159 effective in 2008
The Fair Value Option for Financial Assets and Financial Liabilities
Advantages:
■ Eliminate arbitrary FAS 115 classifications that can be used by management to
manipulate earnings (which is what Freddie Mac did in 2001 and 1002.
■ Provide a better snap shot of values and risks at each point in time. For example,
banks now resist fair value accounting because they do not want to show how
investment securities have dropped in value.
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FAS 159 effective in 2008
The Fair Value Option for Financial Assets and Financial Liabilities
Disadvantages:
Combines fact and fiction in the sense that unrealized gains and losses due to fair value adjustments are
combined with “real” gains and losses from cash transactions. Many, if not most, of the unrealized gains and
losses will never be realized in cash. These are transitory fluctuations that move up and down with transitory
markets. For example, the value of a $1,000 fixed-rate bond moves up and down with interest rates when at
expiration it will return the $1,000 no matter how interest rates fluctuated over the life of the bond.
■ Sometimes difficult to value, especially OTC securities.
■ Creates enormous swings in reported earnings and balance sheet values.
■ Generally fair value is the estimated exit (liquidation) value of an asset or liability. For assets, this is often
much less than the entry (acquisition) value for a variety of reasons such as higher transactions costs of entry
value, installation costs (e.g., for machines), and different markets (e.g., paying dealer prices for acquisition
and blue book for disposal). For example, suppose Company A purchases a computer for $2 million that it can
only dispose of for $1 million a week after the purchase and installation. Fair value accounting requires
expensing half of the computer in the first week even though the computer itself may be utilized for years to
come. This violates the matching principle of matching expenses with revenues, which is one of the reasons why
fair value proponents generally do not recommend fair value accounting for operating assets.
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FAS 159 effective in 2008
The Fair Value Option for Financial Assets and Financial Liabilities
Disadvantages of Auditing FV
The purpose of this International Standard on Auditing (ISA) is to establish
standards and provide guidance on auditing fair value measurements and
disclosures contained in financial statements. In particular, this ISA addresses
audit considerations relating to the valuation, measurement, presentation and
disclosure for material assets, liabilities and specific components of equity
presented or disclosed at fair value in financial statements. Fair value
measurements of assets, liabilities and components of equity may arise from
both the initial recording of transactions and later changes in value.
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FAS 159 effective in 2008
The Fair Value Option for Financial Assets and Financial Liabilities
Exclusions:
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IASB Discussion Paper
1-68
IASB FVO in Amended IAS 39
■ The European Commission has published Frequently Asked Questions providing the Commission's views on the
following questions:
■ Why did the Commission carve out the full fair value option in the original IAS 39 standard?
■ Do prudential supervisors support IAS 39 FVO as published by the IASB?
■ When will the Commission to adopt the amended standard for the IAS 39 FVO?
■ Will companies be able to apply the amended standard for their 2005 financial statements?
■ Does the amended standard for IAS 39 FVO meet the EU endorsement criteria?
■ What about the relationship between the fair valuation of own liabilities under the amended IAS 39 FVO
standard and under Article 42(a) of the Fourth Company Law Directive?
■ Will the Commission now propose amending Article 42(a) of the Fourth Company Directive?
■ What about the remaining IAS 39 carve-out relating to certain
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FAS Standards Greatly Affected by FV
1-70
IFRS Standards Greatly Affected by FV
1-71
IFRC 13 and Fair Value
■ Question
What's the status of international accounting for customer loyalty
incentive awards such as airline miles, first class upgrades, hotel
discounts, restaurant discounts, etc.?
■ Answer
There is a deferred revenue and liability recognition for future
cost requirement. Allocation of the original sale is to be based
upon estimated fair value of components of the sale.
1-72
IFRC 13 and Fair Value
■ 1. The main issue addressed in the Interpretation is the recognition and measurement of obligations to
provide customers with free or discounted goods or services if and when they choose to redeem loyalty
award credits.
■ 2. One approach used at present is to accrue an expense at the time of the sale, when the award credits are
granted. The expense is based on the costs the entity expects to incur to supply the free or discounted goods
or services. The rationale for this approach is that loyalty awards are incidental costs of securing the first
sale, which should be recognised when that sale is made.
■ 3. A second approach is to divide the proceeds of the first sale into two components—an amount that
reflects the value of the goods or services delivered in the first sale and an amount that reflects the value of
the loyalty award credits. Proceeds allocated to the first component are recognised as revenue at the time of
the first sale. But proceeds allocated to the award credits are deferred as a liability until the entity fulfils its
obligations in respect of the award credits, either by supplying the free or discounted goods or services itself
when customers redeem the credits, or engaging (and paying) a third party to do so.
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IFRC 13 and Fair Value
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A Formula to Remember for Later in the Day
1-75
Checklist for Valuing a Company
Compilation of Financial Information: Financial statements and federal income tax returns for
the last three to five years should be reviewed and the information "adjusted" and/or
"weighted" to more properly reflect future operations:
■ Audited vs. unaudited statements to reflect accurate levels of inventories and receivables.
■ Determine latest work-in-process value -- particularly where production costs have been
expensed rather than capitalized.
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Checklist for Valuing a Company
■ Add back any "excess" owner/employee cash compensation and fringe benefits.\
■ Determine net fair market value for tangible assets (eg., book value vs. liquidation
value vs. replacement value of equipment, obsolete or slow-moving inventory,
supplier return privileges, credits, etc.).
■ Determine undisclosed and/or disputed liabilities (eg., unfunded past service costs or
multi-employer obligations for pension plans, deferred compensation plans;
incentive bonuses; stock options; potential contract or tort claims; potential
unfunded sales income or payroll tax obligations).
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Checklist for Valuing a Company
Valuation:
There is usually no "magic" correct value but rather an
appropriate range of values dependent upon the "fit" of
buyer and seller and the realism of the assumptions
utilized in the valuation methodology. Also,
consideration should be given to internal expressions of
valuation (eg., buy-sell agreements, insurance
arrangements, and deferred compensation and
noncompetition agreements).
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Checklist for Valuing a Company
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Checklist for Valuing a Company
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Checklist for Valuing a Company
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Free Online Real Estate Appraisals
Local Links --- ..\..\..\Tidbits\2007\tidbits070809.htm
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Banking Concerns
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The End
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