Chapter 3 Professional Standards

• Jurisdiction: United States

Chapter 3 Professional Standards

This chapter provides an overview of several accounting and valuation professional standards as examples regarding various definitions and explanations of financial forecasts and projections within the broader scope of the potential prospective financial information that may be available for analysis. Several significant standards bodies are considered, although others may also be relevant depending on the application, setting for interpretation, and relevant case law.

As described in detail in Chapter 2, although budgets, forecasts, projections and pro forma financial statements may appear to be similar, they are different documents prepared for separate purposes. In addition, these documents may be prepared for different audiences. Documents prepared for internal discussion may have different interpretations and consequences compared with documents prepared for external communication. In addition, the level of rigor employed in the preparation and detail reflected in the presentation may vary depending on the audience or regulatory requirements involved. Financial professionals, valuation analysts and experts, and counsel should be aware of these distinctions.

In particular, accounting, financial and valuation experts may be bound by professional standards that may govern their use and interpretation of budgets, forecasts, projections and pro forma financial statements. Users of this information may want to consider the guidance offered by leading professional organizations about the preparation, use and interpretation of this financial information. Counsel should also be aware of these standards, because they can provide useful avenues for interpreting and questioning management and valuation experts who are providing services in a litigation setting.

A Note About Language

The language involving terms such as "appraisal" and "valuation" can have differing connotations, even though professionals may use the same or similar words. The presence or absence of professional designations by an individual who is performing the analysis may or may not affect the interpretation of their work and supporting analysis. For example, the word "appraisal" may have different meanings and interpretations. Does the word "appraisal" imply a plain-English definition, or does it imply a professional definition regarding the act of assessing and reaching a valuation conclusion, or may it be interpreted more narrowly as only referring to a professionally signed statement of an appraisal opinion issued by a professional who is certified in the appraisal profession? Is a university professor who teaches and offers opinions about value, but who is not certified in the appraisal profession, still providing a valid appraisal opinion about the value of a business or assets? Is a financial analyst who reaches an opinion of value appraising the business or asset? Who decides, in what setting, and under which legal requirements and definitions? These, and other related questions, should be considered in order to evaluate the context of the analysis and the relevance of the conclusions reached.

Similarly, professional associations and published texts may use or imply differing meanings for terms such as budgets, forecasts, projections, etc. Our goal is not to assign priority among these writings or to reconcile their differing intended meanings. Rather, we present them as examples in order to raise awareness that users of this information need to inquire into the language employed in each situation to understand the terms being used in order to fully appreciate and respond to the documents and records at issue.

For our purposes within this publication, we treat an "appraisal professional" as a person who is a certified professional operating under defined professional standards set by organizations that define the methods and practices of valuation analysis. We use the words "valuation analyst" more generally, applying this term to any person who is performing a valuation analysis and reaching a conclusion and providing an opinion of value. This more general treatment is intended to facilitate our discussion about prospective financial information without debating any priority among the various professional organizations or among analysts in general.

We recognize that the courts reach their own opinions, on a case-by-case basis, regarding the identification and qualifications of "experts" who may or may not be admitted and allowed to present their expert opinions about valuation conclusions to a jury or other trier of fact. We also recognize that the use or acceptance of appraisals and valuation conclusions, in general, may be determined by the situation and the requirements of, and intended purposes of, the preparation of such information for the intended users of that information. Thus, we offer no opinion within this publication about which professional standards may or may not be applicable to a particular valuation engagement or litigation setting. In general, we utilize the terms "financial expert" or "valuation expert" to convey the context where a valuation analyst presents their conclusions and expert opinions in a courtroom or other litigation setting. We also note the distinction in roles between an "expert" who may be disclosed to opposing counsel versus a "litigation consultant" who may possess professional expertise but who does not offer an opinion to the court and who may not be disclosed to opposing counsel in a litigation environment. For purposes of this publication, we assume that the litigation consultant has the requisite professional expertise to select and perform the relevant analysis, and we do not draw a distinction between these professional service roles.

Finally, given the varying terminology and interpretations of the words "budget," "projection," "forecast" and "pro forma," we apply the term "prospective financial information" as a general term to all of these (and any related) documents to facilitate our discussion.

American Institute of Certified Public Accountants (AICPA)

In the U.S., the Certified Public Accountant (CPA) designation is granted at the state level. The National Association of State Boards of Accountancy (NASBA) serves the 55 state boards of accountancy, which regulate the accounting profession in the U.S. There is one board for each of the 50 states, plus the District of Columbia, Puerto Rico, U.S. Virgin Islands, Guam and the Northern Mariana Islands. Since CPAs are regulated under state law, the professional standards and guidance that govern CPAs may carry the weight of law, or convey legal implications, thereby functioning as more than professional guidance. Note that NASBA acts primarily as a forum for the state boards themselves, as opposed to the AICPA, which represents CPAs as individuals. Although individual CPAs are not required to belong to the AICPA, many do.

The AICPA was founded in 1887 as the national professional organization of CPAs in the U.S. It has more than 418,000 members in 143 countries in business and industry, public practice, government, education, student affiliates and international associates. It sets ethical standards for the profession, including U.S. auditing standards for audits of private companies, nonprofit organizations, and federal, state and local governments.²⁶ The AICPA's Forensic and Valuation Services Executive Committee oversees the AICPA's Business Valuations Committee.²⁷

Financial statements often, but not always, follow the pronouncements of the Financial Accounting Standards Board (FASB), which develops and promulgates the Generally Accepted Accounting Principles (GAAP).²⁸ The AICPA provides technical support and standard-setting (including GAAP), and provides guidelines in conjunction with FASB's work.²⁹

In June 2007, the AICPA recognized that many of its members were performing business valuation services and issued the Statement on Standards for Valuation Services No. 1 (SSVS-1). This document is now labeled as AICPA valuation standard "VS Section 100." SSVS-1/VS 100 has become a widely cited important addition to the valuation literature, since it explains the nature of an AICPA-defined valuation engagement and the contexts in which business valuation may be performed (i.e., in engagements involving transactions, litigation, regulatory compliance and business planning). It provides many definitions, classifications of related analysis and reporting, and determinants of how AICPA members are expected to perform a valuation engagement. For example, it instructs the valuation analyst to seek and analyze a range of financial information involving the subject of the valuation analysis, including the company's prospective financial information (i.e., budgets, fore-casts and projections).³⁰ SSVS-1/VS 100 does not discuss the interpretation or use of prospective financial information, since these subjects are explained elsewhere in the accounting literature.

The AICPA addresses questions about forecasts and projections in the AICPA Professional Standards at AT-C Section 305 (formerly AT Section 301), Prospective Financial Information. According to the AICPA, "prospective financial statements" are:

[e]ither financial forecasts or financial projections, including the summaries of significant assumptions and accounting policies. Although prospective financial statements may cover a period that has partially expired, statements for periods that have completely expired are not considered to be prospective financial statements.³¹

With that perspective, the AICPA goes on to define a financial forecast and a financial projection as follows:

Financial forecast — Prospective financial statements that present, to the best of the responsible party's knowledge and belief, an entity's expected financial position, results of operations, and cash flows. A financial forecast is based on the responsible party's assumptions

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