‘Valuation is the process of
determining the economic worth of a subject under certain assumptions and
limiting conditions for a particular purpose on a particular date.’
The above
description comes closest to defining ‘Valuation’ from a financial and economic
perspective. Such a process of valuation usually culminates into an ‘estimation
of value’, that is generally performed by a person with the desired skill-sets.
Since long, the valuation exercises have been the domain of various
subject-matter-experts, each claiming to be one in a specific category. The
nuances of such specific categories, e.g. real property, financial assets,
personal assets, intangibles, etc., ensured that the profession of valuation
remained scattered across various professional silos operating in a particular
domain area.
In the recent past, various
developments and factors in the Indian context have contributed to the
thought-process of creating a distinct class of professionals who would be
entrusted with the responsible need of performing valuations. The shift to the
fair-value based financial reporting, fragmented regulatory regime surrounding
valuations, advent of the insolvency and bankruptcy code and enhanced
stakeholder expectations, were the key contributors to the thought-process of
creating a distinct class of professionals to focus on performing valuations.
The Companies Act, 2013 (‘Act’), more specifically section 247 therein,
incarnated this distinct class of professionals as ‘Registered Valuers’.
The Act envisages an entire
framework under which the Registered Valuer is expected to function. Amongst
the many constituents of this framework, is an important obligation on the
Registered Valuer to ensure the conduct of the valuation exercise is in
accordance with the valuation standards as notified by the Central Government. Unlike
the other contemporaries, being Accounting Standards, Auditing Standards,
Standards of Internal Audit, etc., the Valuation Standards have, in a sense, a
self-defeating role in standardising the judgments, estimations,
subjectivities, presumptions and perceptions that are the inherent basis and
purpose of a valuation exercise. Each of these attributes are a clear
antithesis to ‘standardisation’. Having said that, there is a real opportunity
to standardise the processes surrounding valuation and the broad contours of a
valuation exercise, basis of which a valuation professional can apply
his expertise.
Globally, there are different
valuation standards that are applicable to different jurisdictions. More
notable ones being (a) the International Valuation Standards (‘IVS’)
issued by the International Valuations Standards Council, applicable to various
countries, (b) the Uniform Standards of Professional Appraisal Practice (‘USPAP’)
issued by The Appraisal Foundation – USA (‘TAF’), predominantly
applied in the United States of America and (c) European Valuation Standards (‘EVS’)
as issued by The European Group of Valuers’ Association, applicable to certain
countries in the European region. These prominent sets of valuation standards
are more different than similar in their construct, approach, guidance and
application. Whilst attempts are being made to bridge the divergence between
these prominent valuation standards, significant differences remain between
these prominent international standards. Whilst the IVS tend to be highly
principle-based in their approach, the EVS and USPAP are fairly rule-based in
their approach. The EVS ecosystem particularly also provides detailed technical
guidance on nuances of the valuation process through guidance notes, codes and
technical documentation.
Indian Regulatory Position on Valuation
Standards
Rule 8 of Companies (Registered
Valuers and Valuation) Rules, 2017 mandates every Registered Valuer to comply
with valuation standards as notified by the Central Government.
Till date, no valuation standards
have yet been notified under the Companies Act, 2013 and the duty has been
entrusted to a committee formed by the central government, i.e. ‘Committee to
advise on valuation matters’ to recommend the valuation standards to the
Central Government for an eventual notification on their applicability.
The Act envisages 3 (three)
different asset classes, being a) Land and Building, b) Plant and Machinery and
c) Securities or Financial Assets; and the Registered Valuer shall practice
only in the specific asset class for which the Registered Valuer is qualified
for. Intangible assets are a part of Securities or Financial Assets. One would
expect that the committee would recommend valuation standards separately for
each asset class. It will be interesting to observe the outcome of this process
and the road map set by the committee for promulgation of valuation standards
under the Act.
Until such time the Central
Government formulates and notifies the valuation standards, the Registered
Valuer shall perform valuation engagements in accordance with (a) internationally
accepted valuation standards or (b) valuation standards adopted by any
registered valuation organisation.
Meanwhile, the Institute of
Chartered Accountants of India (‘ICAI’) recognising the need to
have consistent, uniform and transparent valuation policies and harmonise the
diverse practices in use in India, constituted the Valuation Standards Board (‘VSB’)
on 28th February, 2017. The composition of the VSB is broad-based
and ensures participation of all interest groups in the standard-setting process.
Amongst various other functions, the main function of the VSB is to formulate
Valuation Standards to be recommended by ICAI to Registered Valuers
Organisations in India, the Government and other regulatory bodies in India and
abroad for adoption and implementation. Based on the recommendation of the VSB,
the ICAI at its landmark 375th meeting issued a set of Valuation
Standards aka ‘ICAI Valuation Standards’.
These ICAI Valuation Standards are
applicable to members of the ICAI for all valuation engagements on a mandatory
basis under the Companies Act, 2013. In respect of valuation
engagements under other statutes like Income Tax, SEBI, FEMA, etc., it will be
on recommendatory basis for the members of the Institute. These Valuation
Standards are effective for the valuation reports issued on or after 1st
July, 2018. There are currently 8 (eight) valuation standards along with
Preface and Framework documents that have been made applicable by the ICAI.
They are as follows:
a. Preface
to the ICAI Valuation Standards
b. Framework
for the Preparation of Valuation Report
c. ICAI
Valuation Standard 101 – Definitions
d. ICAI
Valuation Standard 102 – Valuation Bases
e. ICAI
Valuation Standard 103 – Valuation Approaches and Methods
f. ICAI
Valuation Standard 201 – Scope of Work, Analyses and Evaluation
g. ICAI
Valuation Standard 202 – Reporting and Documentation
h. ICAI
Valuation Standard 301 – Business Valuation
i. ICAI
Valuation Standard 302 – Intangible Assets
j. ICAI
Valuation Standard 303 – Financial Instruments
The standards have been neatly
grouped into three different number scalable series, with 1XX series dealing
with a set of standards that are fundamental common principles being applicable
to across asset classes, the 2XX series dealing with the specifics of
performing a valuation engagement and the 3XX series dealing with explicit
matters in relation to an asset class. The currently applicable ICAI Valuation
Standards cover only the asset class of Securities or Financial Assets under
the 3XX series. On the other hands, the IVS as issued by International
Valuation Standards Council are as below:
a. International
Valuation Standards Framework
b. International
Valuation Standards 101 – Scope of work
c. International
Valuation Standards 102 – Investigations and Compliance
d. International
Valuation Standards 103 – Reporting
e. International
Valuation Standards 104 – Bases of Value
f. International
Valuation Standards 105 – Valuation Approaches and Methods
g. International
Valuation Standards 200 – Business and Business Interests
h. International
Valuation Standards 210 – Intangible Assets
i. International
Valuation Standards 300 – Plant and Equipment
j. International
Valuation Standards 400 – Real Property Interests
k. International
Valuation Standards 410 – Development Property
l. International
Valuation Standards 500 – Financial Instruments
Since the ICAI Valuation Standards
are mandatory for chartered accountants, we shall discuss in detail on those
standards. The ICAI Valuation Standards are drafted by a committee of experts
appointed by the VSB and are curated keeping in sight the nuances surrounding
the valuation ecosystem in India alongwith the peculiar conditions of the
Indian regulatory regime. A synopsis of the ICAI Valuation Standards and key
provisions in each of the above standards is covered below:
a. Preface
to the ICAI Valuation Standards
The Preface acts a precursor
to understanding the backdrop to valuation standards. The preface delves
in detail into formation and functioning of the Valuation Standards Board, the
scope of valuation standards and the procedure to issue a valuation standard.
The mandatory nature of the standards is also an attribute being derived from
the Preface.
b. Framework for the Preparation of Valuation Report
The Framework sets out the concepts
that underline the preparation of valuation reports in accordance with the ICAI
Valuation Standards. The Framework acknowledges the fact that the ICAI
Valuation Standards may not be able to cover every nuance of a valuation
engagement and accordingly a valuation professional is expected to apply his
judgment to the matter. The Framework further elaborates the factors on which
the judgment should be based including the regulatory guidance surrounding such
an application of judgment. The Framework prescribes
a) Understandability, b) Reliability and c) Reliance as the three principal
qualitative characteristics that make the information in the valuation report
useful to the users of the valuation report. The Framework also prescribes
fundamental ethical principles to be followed by the valuation professional,
being a) Integrity and fairness, b) Objectivity, c) Professional competence and due care, d) Confidentiality and
e) Professional behaviour.
In case of a conflict between the
ICAI Valuation Standards and Framework, the provisions of ICAI Valuation
Standards would prevail.
c. ICAI
Valuation Standard 101 – Definitions
The objective of this valuation
standard is to prescribe specific definitions and principles which are
applicable to the ICAI Valuation Standards, dealt specifically in other
standards. The definitions enunciated in this standard shall guide and form the
basis for certain terms used in other ICAI Valuation Standards.
The standard prescribes 48
definitions that are used in other ICAI Valuation Standards. Various terms
which are more generally and colloquially used have been defined in this
standard, e.g. As-is-where-is Basis, Goodwill, Fair value, Forced Transaction,
Highest and best use, Observable inputs, etc.
It is evident from the drafting of
the standard that an attempt has been made to maintain parity of common
definitions that are also defined in the accounting standards.
As-is-where-is Basis: The term
as-is-where-is basis will consider the existing use of the asset which may or
may not be its highest and best use.
d. ICAI
Valuation Standard 102 – Valuation Bases
This standard defines important
valuation bases, prescribes the measurement assumptions on which the value will
be based and explains the premises of values.
‘Valuation Base’ is as an
indication of the type of value being used in an assignment. Different
valuation bases may lead to different conclusions of value. Therefore, it is
important for the valuation professional to identify the bases of value
pertinent to the engagement. This standard defines the following valuation
bases:
(a) Fair value;
(b) Participant specific value; and
(c) Liquidation value
On the other hand, ‘Valuation
Premise’ refers to the conditions and circumstances of how an asset is
deployed.
In a given set of circumstances, a
single premise of value may be adopted while in some situations multiple
premises of value may be adopted. Some common premises of value prescribed in
the standard are as follows:
(a) highest and best use;
(b) going concern value;
(c) as is where is value;
(d) orderly liquidation; or
(e) forced transaction.
A valuation professional shall
select an appropriate valuation base considering the terms and purpose of the
valuation engagement. The standard also recognises the multiplicity of
‘valuation premises’ based on the conditions and circumstances how an asset is
deployed.For instance, a ‘Liquidation Value’ being the ‘Valuation Base’ with
‘Forced Transaction’ being the ‘Valuation Premise’ can result in a completely
different valuation outcome for a same asset being valued on a ‘Fair Value’ as
‘Valuation Base’ with ‘Highest and Best Use’ as the ‘Valuation Premise’.
e. ICAI
Valuation Standard 103 – Valuation Approaches and Methods
The objective of this standard is
to provide guidance on different valuation approaches and methods that can be
adopted to determine the value of an asset. The standard lays down three main
valuation approaches:
(a) Market
Approach
(b) Income
Approach
(c) Cost
Approach.
The appropriateness of a valuation
approach for determining the value of an asset would depend on valuation bases
and premises. The standard requires that valuation approaches and methods shall
be selected in a manner which would maximise the use of relevant observable
inputs and minimise the use of unobservable inputs. It is also possible to use
multiple methods to arrive at combination value or weighted value.
ICAI Valuation Standard 103 is one
of the lengthiest of the valuation standards and delves on various commonly
used methods that are adopted vis-à-vis the different approaches. Few of the
methods discussed under this standard include:
(a) Market Approach Methods:
i. Market
price method
ii. Comparable
companies multiple method
iii. Comparable transaction multiple method
(b) Income
Approach
i. Discounted
cash flow method
ii. Relief
from royalty method
iii. Multi-period excess earnings method
iv. With
and without method
v. Option
pricing method
(c) Cost Approach
i. Replacement
cost approach
ii. Reproduction
cost method
f. ICAI
Valuation Standard 201 – Scope of Work, Analyses and Evaluation
This standard prescribes the basis
for (a) determining and documenting the scope/terms of a valuation engagement,
responsibilities of the valuer and the client; (b) the extent of analyses and
evaluations to be carried out by the valuer; and (c) responsibilities of the valuer
while relying on the work of other experts.
The standard prescribes detailing
of certain key attributes that form a part of a valuation engagement and such
attributes must be documented by way of an engagement letter. The minimum
contents of an engagement letter are also prescribed in the standard.
The standard is an important
guiding factor for the extent of analyses and evaluation that should be
conducted by a valuation professional in conducting the valuation exercise,
including the level of review of non-financial information, ownership
information, general information, subsequent events, etc. The standard also
provides guidance on necessary evaluation to be conducted by the valuation
professional in placing reliance on the work of other experts.
In placing reliance on the work of
other experts, the valuer shall evaluate the skills, qualification, and
experience of the other expert in relation to the subject matter of his
valuation. It is for the valuer to evaluate whether the expert has sufficient
resources to perform the work in a specified time frame and also explore the
relationship which shall not give rise to a conflict of interest.
If the work of any third party
expert is to be relied upon in the valuation assignment, the description of
such services to be provided by the third party expert and the extent of
reliance placed by the valuer on the expert’s work shall be documented in the
engagement letter. The engagement letter should document that the third party
expert is solely responsible for their scope of work, assumptions and
conclusions.
g. ICAI
Valuation Standard 202 – Reporting and Documentation
The objective
of this Standard is to prescribe the minimum contents of the valuation report
depending upon the nature of the engagement and specify the responsibility of a
valuer in preparing the relevant documentation for arriving at a value. The
standard also deals with the functionality of a management representation and
its limitations.
In relation to the documentation to
be maintained by a valuation professional, the standard provides adequate
direction in relation to maintenance of sufficient and appropriate evidence of
the valuation exercise. The minimum set of documentation that should be
preserved by the valuation professional is also prescribed by the standard.
h. ICAI
Valuation Standard 301 – Business Valuation
This standard provides guidance for
valuation professionals who are performing business valuation or business
ownership interests valuation engagements. The standard acknowledges the fact
that such a business valuation may be carried out for various different
purposes including for financial transactions, dispute resolution, reporting
requirements, compliance requirements, internal planning, etc.
The standard lays down a
step-by-step methodology in performing business valuation as under:
(d) define
the premise of the value
(e) analyse
the asset to be valued and collect the necessary information;
(f) identify
the adjustments to the financial and non-financial information for the
valuation;
(g) consider
and apply appropriate valuation approaches and methods;
(h) arrive
at a value or a range of values; and
(i) identify
the subsequent events, if any.
The standard also provides guidance
on commonly used methods for business valuation across the different approaches
that are used in the valuation of a business.
i. ICAI
Valuation Standard 302 – Intangible Assets
In an increasing knowledge-driven
new-age economy, the valuation of intangibles is of greater and heightened importance.
The objective of this standard is to prescribe specific guidelines and
principles which are applicable to the valuation of intangible assets that are
not dealt with specifically in another ICAI valuation standard. The standard
defined an intangible asset as an identifiable non-monetary asset without
physical substance. The interplay of goodwill with intangible assets and their
distinct natures is well enshrined in the standard.
The standard
elucidates on the various types of intangible assets and goes on to provide
detailed guidance on various methods that are commonly used in valuation of
intangible assets across the different valuation approaches. Apart from other
methods, the greenfield method and the distributor method are also guided for
in the standard.
j. ICAI
Valuation Standard 303 – Financial Instruments
The term ‘financial instrument’ has
a common adaption across financial reporting and valuation. This standard
establishes principles, suggests methodology and considerations to be followed
by a valuation professional in performing valuation of financial instruments.
For the purposes of this Standard, financial instrument is any contract that
gives rise to a financial asset of one entity and a financial liability or
equity instrument of another entity. Equity instruments, derivatives, debt
instruments, fixed income and structured products, compound instruments, etc.,
are certain examples of financial instruments.
The principles laid down in this
standard are generally consistent with the broad principles of Ind AS, although
the Ind AS provide far more detailed guidance including specific
classifications of inputs (level 1, level 2 and level 3) and their preferred
usage in a valuation exercise.
Acknowledging the prevalence of
market, income and cost approach, the standard discourages the use of cost
approaches as it is more commonly used in non-financial asset valuation.
Amongst various other matters, the standard deals with certain special
considerations surrounding (a) the entity control environment, (b) the
determination of present value in a valuation technique, (c) adjustment to
credit risks in a valuation exercise.
Conclusion
As evident from the above synopsis,
the ICAI Valuation Standards set the right platform for a valuation professional
to perform his valuation exercise. These standards have put in place various
guard-rails to which the subjectivity and estimation element of a valuation
exercise, can be subjected to. One of the important enhancements to the quality
of valuation reporting under the ICAI Valuation Standards is the enhanced
disclosure requirements that are mandated by the ICAI Valuation Standards.
The minimum disclosure requirements
also enhance comparability and provide a sense of underlying assumptions that
are considered by the valuer in making his assessment.
Given this fact and the
cohesiveness of the ICAI Valuation Standards adequately capturing the Indian
nuances, it would not be surprising if the ‘Committee to advise on valuation
matters’ as set up by the Ministry of Corporate Affairs recommends the ICAI
Valuation Standards as notified valuation standards under the Act, especially
for the securities and financial assets class.
One will need
to wait and watch the adoption of ICAI Valuation Standards by other registered
valuation organisations and their applicability for other regulatory purposes.
The ICAI Valuation Standards pushes the practice of valuation into certain
required rigours of documentation, reporting, reliance on experts, evaluation
of a control environment, etc., that would only act as a catalyst to further
enhance the reliance on the report of the valuation professional. While the
domain does not and by its very nature cannot, remove the element of
‘subjectivity’, the robust nature of ICAI Valuation Standards alongwith the
enhanced disclosure requirements have the potential go a long way in setting
the right principles and providing the right directional clarity to the
professional valuer performing a valuation exercise. The needle of balance
between subjectivity and standardisation has certainly moved a fair bit towards
standardisation.
