Concept of valuation

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Concept of valuation

Corporate valuations, whether of physical, financial or intangible assets owned by a company, play an important role in guiding decisions involving investment and risk. This holds for capital market decisions, corporate restructuring, mergers and amalgamations, formation of joint ventures and strategic alliances between the companies. Valuation of the company and its assets and undertaking in a credible manner, taking into account various aspects relating to it, with the application of well recognized and rational criteria is being perceived as increasingly important. Credible valuations allow decisions to be taken by the stakeholders in a company with confidence. Equally, all existing and would-be stakeholders in a company, rely on expert valuations while assessing disclosures made by a company and the degree of risk associated with their decisions. Keeping in view the growing relevance and importance of valuations in business and investment decisions as well as in company processes, the need for application of valuations as a specialized discipline, regulated through a credible institutional mechanism set up under a statute, has been increasingly felt. There is a need for a fully articulated academic institutional and regulatory framework for this discipline. The expert qualification of “valuation” has to be based on recognized professional courses of study, certified by a properly constituted statutory body. At the same time, valuers also need to adhere to a proper code of professional conduct with an institutional mechanism for review and discipline in cases of misconduct.

Six Valuation Concepts

1.Historical cost is the conventional valuation concept used in accounting. Resources are valued in accordance with their cost of acquisition by the enterprise. The historical cost valuation concept poses many difficulties under price-level changes.

2.Present value, which is a concept which relates the value of an asset to the decision to hold it and to derive its utility from using it in the production of income. The present value is defined as the sum of the future expected net cash flows associated with the use of the asset, discounted to its present value.

3.Current purchasing power, which is basically an adjusted historical cost concept, in which adjustments are made to recorded historical cost values for changes in the purchasing power of money by means of a consumer price index.

4.Current replacement cost, in which the value of an asset is determined by the current cost of replacing it, and using the replacement to maintain the same service to the enterprise. It requires current market price data as a basis for preparing financial reports.

5.Net realizable value, which estimates the value of an asset to the enterprise as the amount which would be realized from its sale, after adjusting for selling expenses.

6.Current cost accounting which is a valuation concept which combines the concept of current replacement cost and net realizable value in determining whether selling (exit) or buying (entry) prices should be used for the purposes of establishing the value of an asset to the business.

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