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Valuations and Independence: A Complex Issue

Gelman, Rosenberg & Freedman CPAs is a member of CPAmerica International, an association of CPA and consulting firms that provides industry knowledge including insightful articles, to help member firms serve clients and other individuals and organizations.

Accountants and valuations analysts are often asked by clients to prepare a valuation of their business, but sometimes they have to pass on the work. Why?

If the CPA or analyst’s firm also performs audit engagements for the company, there could be what is called a lack of independence, which is required for all firms performing audits. The decision about whether independence may be impaired is becoming increasingly complex and must be evaluated on a case-by-case basis.

CPA working

It can depend on information a client reveals in private conversations – or the firm has access to – on the way those valuations will ultimately be used.

For example, a firm was engaged to prepare annual audits for a company for several years and had a long-standing relationship with the client. The majority stockholder wanted a company valuation for the gifting of a substantial portion of his stock to his son, who is a member of the company’s management.

Under normal circumstances, and in compliance with the independence rules for attest engagements, the valuation analyst would have been able to prepare the valuation. After all, who knows clients better than their auditor?

However, during a lunch meeting, the client (majority stockholder) revealed that he was in the process of a messy divorce and his wife’s lawyer was pushing for a substantial portion of his value in the company to be included in the matrimonial assets. He indicated that he would have his lawyer use the valuation to rely on his ownership value, if needed.

Upon hearing this, the conversation shifted to referring the valuation to another analyst or accountant. Usually, the auditor’s independence would not be infringed upon under American Institute of Certified Public Accountants (AICPA) standards and regulations, Rule 101 – Independence. But in this circumstance, with all things taken into consideration and the possible scenarios that could unfold, independence could be impaired unintentionally, and the valuation engagement was referred elsewhere.

There was the very good possibility the analyst could be called as an expert witness on the valuation, and because of the divorce, the valuation product was discoverable. The result would be that the valuation would not be used for its original intended purpose.

The IRS Business Valuation Guidelines address independence in the following manner:

“Valuators will employ independent and objective judgment in reaching conclusions and will decide all matters on their merits, free from bias, advocacy and conflicts of interest.”

 

Pretty vague. In other words, the IRS will decide if that analyst is independent, and that decision will be based on the individual circumstances and the appearance of independence.

The National Association of Certified Valuation Analysts (NACVA) addresses independence by stating that a member shall not express a conclusion of value unless the member and the member’s firm state either of the following:

“We have no financial interest or contemplated financial interest in the property that is the subject of this report” or

We have a (specified) financial interest or contemplated financial interest in the property that is the subject of this report.”

 

NACVA guidelines address independence by requiring that the valuator make it known to the readers their level of independence – independent or not independent.

The decision becomes more difficult if a firm is engaged in attest engagements with the client. The AICPA’s Rule 101 defines independence in very specific terms and gives various examples and interpretations to define or help determine independence for a valuation engagement and other types of engagements.

Basically, the appearance of being independent to an outside party would lead a reasonable person to conclude that a firm is independent. More specifically, the rule addresses appraisal, valuation and actuarial services in the following manner:

“Independence would be impaired if a member performs an appraisal, valuation, or actuarial service for an attest client where the results of the service, individually or in aggregate,would be material to the financial statements and the appraisal, valuation, or actuarial service involves a significant degree of subjectivity.

“Valuations performed in connection with, for example, employee stock ownership plans, business combinations, or appraisals of assets or liabilities generally involve a significant degree of subjectivity. Accordingly, if these services produce results that are material to the financial statements, independence would be impaired.”

Further, it indicates that, if a CPA conditionally or unconditionally agrees to provide expert witness testimony for a client, independence would be considered impaired. The major factor to keep in mind is, if there is not the appearance of independence or there is a question about independence, chances are there is no independence.

Valuations analysts must be aware that their work can be used by clients for different purposes, intentionally or unintentionally, and that could impair their independence on future audit engagements.


The 2010 audit was a pleasant experience for us. I was impressed with the work of Partner Jim Larson and Supervisor Sara Kennedy.

Elena Anderson |  Director of Finance and Operations
Asian and Pacific Islander American Scholarship Fund