Page 291 - DCOM205_ACCOUNTING_FOR_COMPANIES_II

Accounting for Companies – II

Notes
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Case Study The Right Deduction
Client’s Situation
About five days before the deadline to file his annual tax return, a client and his accountant
called us to assist in what they thought would be an easy problem to solve. After all, in
November, 1997, the client (the sole owner of all 600 outstanding common shares of the
subject company) had entered first into a Letter of Intent, then Definitive Agreements to
sell his company for ` 95.0 million. The transaction was to close March 1, 1998.
A stock transaction, the buyer and seller had (appropriately) agreed to a “collar” on the
deal. That is, if the stock to be exchanged by buyer traded at an average price at less than
` 21 per share or more than ` 29 per share for a twenty-day period prior to closing, either
buyer or seller could terminate the transaction. At the date of close, the price of the shares
was ` 18 per share and “out of the money”. Both parties wanted to (and did) terminate the
transaction.
The seller, feeling the chances of closing were almost certain, made a 1997 year end gift to a
charitable foundation of 2 shares of stock. He and his accountant now needed an appraisal
to support and confirm the charitable deduction in Form 1040 to be filed in five days. The
accountant and his client thought that the pro-rata share of the failed transaction would be
the correct value.
ABA Solution
With client agreement, ABA quickly provided a scope-restricted opinion to file with the
tax return. More important, ABA applied appropriate appraisal technique and considered
the non-marketable minority interest that was, indeed, the true gift. ABA also applied
the fair market value standard (hypothetical buyer; hypothetical seller) rather than the
investment value standard (a specific buyer acquiring the company for synergistic and
strategic reasons) to the subject equity interest. While the deduction was not as great as
the client and his accountant first thought, the deduction was correct and supported by a
qualified appraisal opinion completed within a tight timeframe. Both the accountant and
his client appreciated the guidance, and the professional and timely service.
Questions
1. Write down the case facts and analyse the situation.

2. Discuss the solution for the case problem.
Source: http://www.businessval.com/resources/case_studies/right_deduction.pdf

12.6 Summary

z z The methods of valuation depend on the purpose for which valuation is required.
Generally, there are three methods of valuation of shares: Assets basis, Earning basis and
Average basis.

z z A clear understanding of the purpose of valuation is undoubtedly important, but an
equally important imperative is to have a full appreciation of the ‘value’ emanating from
common principles.

z z This ‘general purpose value’ may be suitably modified for the special purpose for which
the valuation is done.

z z The factors affecting that value with reference to the special purpose must be judged and
brought into final assessment in a sound and reasonable manner.

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