Valuation in accounting is a common procedure used to determine the value of an asset for the purposes of financial reporting. This may seem like a relatively simple task overall, but assessing the present value (PV) of certain types of assets can require advanced calculations and thorough understanding of applicable regulations. As with most business accounting practices, there are established standards and regulations that determine how value is determined and reported. However, accountants performing the valuation have several distinct methods they can use depending on the demands of the situation.
Importance of Asset Valuation
There are many reasons for an individual or business to get an accounting valuation of some or all of their assets. Larger business conduct broad valuations during mergers or acquisitions to ensure that the numbers used in a contract are accurate. Determining the value of an individual’s assets is also necessary when dividing property among beneficiaries of a will or during a divorce settlement. It can also be necessary for those required to forfeit assets as a result of a a civil claim or as part of bankruptcy proceedings.
Discounted Cash Flow
The discounted cash flow (DCF) model focuses on calculating intrinsic value of assets to determine future cash flows of an organization. This is the most comprehensive of the three main valuation methods and requires a significant amount of research, analysis and data. DCF accounting practices are characterized by the reduction of future value to establish a present value. Accountants using this method discount the worth of an asset based on present and future factors, including elements of risk that may lower its overall worth.
Accountants can also use a relative pricing model that defines the value of companies or assets based on the price of comparable alternatives. Potential investors may use this model to assess several different companies to find the one with the highest relative value. The method can also be used to calculate an estimation of market value of a particular piece of property or financial instrument. In many cases, relative value models are used alongside more comprehensive methods when valuing a company.
Option pricing, also known as continent claim valuation, is typically used to find the value of specific financial items. It is particularly useful for defining the worth of long-term assets, like stock options and securities. There are actually several different types of option pricing models currently in use, including the Black-Scholes-Merton and lattice models. The Association of International Certified Professional Accountants (AICPA) provides detailed guidelines regarding option pricing and other valuation methods for accounting professionals.
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Assessing the worth of contracts, property and financial instruments is far from a simple task. For investors or companies conducting these evaluations, accuracy of the results could have a major impact on the long-term success of their financial ventures. Understanding the complexity of valuation in accounting is essential for any certified accountant, but a familiarity with the basic principles behind these methods is a useful skill for all kinds business or finance professionals.