Business Valuation Body of Knowledge: Exam Review and Professional Reference / Edition 2

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Overview

Praise for the First Edition

"The beauty of this work is that it points the reader to each professional organization's writings on issues relating to business valuation methodologies and applications. I can't think of an attorney who works with business valuation professionals who should not have this book."
-Robert E. Kleeman Jr.
CPA/ABV, ASA, CVA, CFE, Clifton Gunderson, LLC

"Business Valuation Body of Knowledge will quickly become one of the foremost authoritative sources on the 'body of knowledge' for business valuations. It is well organized and written in a style which allows it to be used as both a teaching tool and a reference manual."
-R. James Alerding
CPA/ABV, ASA, CVA, Clifton Gunderson, LLC

"When you simply need the answer, Shannon has it for you. The Body is a no-nonsense repository of information!"
-Stephen J. Bravo
CPA/ABV, CBA, CPF, PFS, Apogee Business Valuations, Inc.

"This book is a 'must have' for every business valuation library. . . . [Shannon has] done an excellent job of compiling a core body of knowledge that is common to all of the major accrediting organizations in the business valuation profession."
-Thomas E. Hilton
CPA, CVA, Anders, Minkler & Diehl, LLP

"The book is great. I especially like the cost of capital chapter. . . . It's one of the few books where there is a succinct description of the different methods to determine the cost of capital. I thoroughly enjoyed reading it and it was a great refresher for me."
-Mary McCarter
ASA, CFA, Columbia Financial Advisors, Inc.

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Product Details

  • ISBN-13: 9780471403074
  • Publisher: Wiley, John & Sons, Incorporated
  • Publication date: 1/1/2003
  • Edition description: Second Edition
  • Edition number: 2
  • Pages: 384
  • Product dimensions: 6.14 (w) x 9.29 (h) x 1.14 (d)

Meet the Author

Shannon P. Pratt, CFA, FASA, MCBA, CM&AA, is the Chairman and CEO of Shannon Pratt Valuations, Inc. a premier business valuation firm located in Portland Oregon, and is the founder and Editor Emeritus of Business Valuation Resources, LLC. Over a distinguished career of close to four decades, he has performed valuation engagements for M&A, ESOPs, gift and estate taxation, marital dissolution, shareholder oppression and dissent, and numerous other purposes. He has conducted numerous fairness and solvency opinions, has testified in a wide variety of federal and state courts across the country, and frequently participates in arbitration and mediation proceedings. Dr. Pratt is one of the most successful and respected authors in his field. He is the author or coauthor of several industry standards, including Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Valuing Small Businesses and Professional Practices, The Market Approach to Valuing Businesses, Standards of Value, Business Valuation and Taxes, The Lawyer's Business Valuation Handbook, and Cost of Capital.
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Read an Excerpt


Business Valuation Body of Knowledge: Exam Review and Professional Reference



By Shannon P. Pratt


John Wiley & Sons



Copyright © 2003

Shannon P. Pratt
All right reserved.



ISBN: 0-471-40307-5



Chapter One


Ownership of a business or an interest in a business or intangible asset consists of a
combination of rights and obligations. Rights and constraints exist whether the interest
is direct or through a partnership, stock, or other form of ownership.

The actual or inferred characteristics of the interest and the pertinent rights and
obligations may vary from one legal context to another. For example, in most tax
contexts, a minority stock position would be valued at something less than a pro rata
portion of the value of the whole (reflecting a minority interest discount and, in most
cases, a discount for lack of marketability). However, in the context of a minority oppression
or dissenting stockholder appraisal, at least in some situations, the same
shares may be determined by law to be worth a pro rata portion of the value of the
whole.

Virtually every professional business valuation engagement is subject to attack
by one or more parties, so it is important for the valuation professional to have some
familiarity with the laws and regulatory environment pertinent to each engagement.


SOURCES OF ATTACK

Legal and RegulatoryAuthorities

Internal Revenue Service (IRS)

Department of Justice (DOJ)

Department of Labor (DOL)

Securities and Exchange Commission (SEC)

State taxing authorities

State eminent domain authorities

State attorney general offices

Parties Related to a Transaction

Direct parties to a transaction

Spouses of parties to a transaction

Beneficiaries

Trustees

Lenders

Parties who in some way may be damaged


VALUE DEPENDS ON PURPOSE OF VALUATION

Often, the same share of stock may have different values depending on the purpose
for which it is being valued. The value of the interest depends on the rights and
obligations pertinent to that interest. Even for the same ownership interest, those rights
(or legally assumed or ignored rights) can differ from one legal context to another.

For example, the same share of stock may have different values for various
purposes:

Gift and estate taxes

Employee stock ownership plans (ESOPs)

Dissenting stockholder or shareholder oppression actions

Marital dissolutions

Partnership or corporate dissolution

Bankruptcy reorganization

Liquidation

Buy-sell agreement pricing

The valuation professional should be aware of the legal, regulatory, and contractual
authorities that affect the acceptable methodology and, thus, often affect the ultimate
value for the particular engagement. Appraisers are not lawyers, but the applicable
law frequently is inextricably intertwined with the valuation.


LEGAL AUTHORITY

Legal authority can be promulgated at the federal, state, or local level, depending
on jurisdiction over a particular transaction.


Federal versus State Jurisdiction

Federal Law

Federal law governs:


Federal estate, gift, and income taxes

ESOPs (under Employee Retirement Income Security Act [ERISA])

Bankruptcy

Public securities transactions

Antitrust law

Patent, trademark, and copyright violations


State Law

State law governs:

State inheritance and income taxes

Ad valorem (property) taxes

Eminent domain proceedings

Marital dissolution

Corporate and partnership withdrawals and dissolutions

Dissenting stockholder suits, shareholder oppression cases, buy-sell agreement
disputes, and other shareholder matters

There are many other types of legal actions in which the appraiser may be involved
(e.g., contract claims, fraud claims, etc.) that can be brought in either federal or state
court at the choice of the suing party, depending on the circumstances of the case.


Types of Legal Authority

Whether under federal or state jurisdiction, most legal authority is promulgated
in one of three forms:

1. Statutory law

2. Legally binding rules and regulations

3. Precedential court decisions


Statutory Law

Federal Statutes

Examples of federal statutes include:

The Internal Revenue Code (IRC), especially section 2031 on estate taxes, section
2512 for gift taxes, and sections 2701 to 2704 on intrafamily transfers

ERISA

The Bankruptcy Code

The Securities and Exchange Act

State Statutes

Examples of state statutes include:

State revenue codes

State commercial codes

State securities codes

State corporation codes (usually a variation of the Model Business Corporation
Act), usually addressing dissenting stockholder valuations

Statutes granting oppressed minority shareholder relief, including an appraisal
option (in a growing number of states)

Marital dissolution statutes, which generally do not address valuation matters


Legally Binding Rules and Regulations

Many legislative bills authorize rules and regulations that have the force of law,
with implementation of the rules and regulations delegated to an administrative authority.
Examples include:

U.S. Treasury regulations

Federal Rules of Evidence and Federal Rules of Civil Procedure (see Chapter 4)

Various state revenue regulations

DOL proposed regulation 29 CFR Part 2510 on Definition of Adequate Consideration
(for ESOP stock)

Proposed regulation was issued in 1988 but never finalized.

Despite lack of finalization, it provides guidance, and most ESOP appraisers
consider compliance with it important.

(See also Chapter 24.)


Precedential Case Law

The details of resolving most valuation issues are not specified in statutes,
and the appraiser should consider the case law of the relevant jurisdiction to determine
how the controlling courts treat various issues. The appraiser should discuss
any legal issues with the attorney. As a practical matter, however, attorneys
often look to the appraiser to be knowledgeable about case law affecting valuation
issues.


Federal Case Law

Exhibit 1.1 summarizes the U.S. federal court system, including the relevant reporting
services for each.


State Court Systems

State court systems vary considerably from one state to another, but most have
trial, appellate, and supreme court levels, in addition to specialized courts.

If a state does not have a precedential case on point for a particular valuation issue,
lawyers' briefs often will cite precedent from court decisions of other states with
similar statutes, and the court's decision usually will cite cases from other states.
In divorce cases and dissenting shareholder cases, decisions vary greatly from
state to state, leading to much confusion in the courts for those states without clear
precedent in their own case law.


IRS AUTHORITY

The IRS publishes its positions on many valuation issues. Although these pronouncements
do not have the force of law, they are widely looked to for guidance on
IRS positions.


Revenue Rulings (RRs)

Official pronouncements of the national office of the IRS.

Designed to provide interpretations of the tax law.

Do not carry the legal force and effect of regulations.

Although regulations are approved by the Secretary of the Treasury, revenue
rulings are not.

Revenue rulings relevant to business valuation include:

RR59-60: Valuation of closely held common stock (the most widely referenced
revenue ruling, also often referenced for nontax valuations).

RR65-193: Eliminates wording about separate appraisals of tangible and
intangible assets from RR59-60.

RR68-609: Excess earnings method (also called formula method or treasury
method). (Should be used only if no better method is available; supersedes
RR65-192; confirms that RR59-60 is applicable to business interests of all
types.)

RR77-287: Discounts for lack of marketability. (Recognizes private placement
studies as relevant empirical data for guidance in quantifying discounts
for lack of marketability; issued before pre-initial public offering [IPO] studies
existed; pre-IPO studies recognized along with private placement studies in
Estate of Mandelbaum v. Commissioner.)

RR83-120: Valuation of preferred stock.

RR85-75: Taxpayer is subject to penalty if he or she adopts overstated amount
on estate tax return for section 1014 basis.

RR93-12: Minority stockholder of family-controlled company is not subject to
family attribution. (Reversed RR81-283.)

Note: Major revenue rulings are elaborated on in Chapter 23. References to topics
addressed in RR59-60, RR68-609, RR77-287, RR83-120, and RR93-12 are noted
wherever relevant topics are discussed throughout this book.


Revenue Procedures (RPs)

Issued in the same manner as revenue rulings.

Deal with IRS internal management practices and procedures.

Revenue procedures relevant to business valuation:

RP66-49: Procedures and report content for contributions of noncash property.

RP77-12: Fair market value of assets purchased through liquidation of a subsidiary.

RP98-34: Option valuation.


Private Letter Rulings (PLRs)

Issued at taxpayer's request about how IRS will treat a proposed transaction.

Apply only to taxpayer who requests and obtains ruling but may provide substantial
authority for avoiding accuracy-related penalties.

Useful as indicator of IRS position on key valuation issues.


Technical Advice Memorandums (TAMs)

Released by IRS national office weekly.

PLRs pertain to proposed transactions; TAMs pertain to completed transactions.

Unlike PLRs, which are initiated by taxpayers not under audit, TAMs arise from
questions raised by IRS personnel during audits.

May not be cited or used as precedent but may provide substantial authority in
avoiding accuracy-related penalties.


Field Service Advice Memorandums (FSAs)

Provide nonbonding advice, guidance, and analysis in response to questions from
IRS agents, attorneys, and appeals officers on both substantive and procedural
issues.

Like TAMs and PLRs, may not be cited as precedent or authority but represent the
current thinking of the IRS.


IRS Valuation Training for Appeals Officers Coursebook

Internal manual used in training course for IRS appeals officers.

May not be cited as authority but useful in understanding IRS thinking on valuation
issues.

Updated periodically (latest edition 1997); latest edition available for reading
and/or downloading at BVLibrary.[com.sup.sm] ; also available in print from CCH,
Incorporated.


IRS Business Valuation Guidelines

Draft issued in May 2001; revised guidelines issued in October 2001.

Available to download from BVLibrary.[com.sup.sm] (at Free Downloads section).

Contain guidelines for developing value, resolution of value, reporting, and a report
checklist.


Chapter Two


Although businesses and business interests have been valued for many decades, most
of the evolution of business appraisal as a profession has occurred in the 1980s and
1990s.


THE APPRAISAL FOUNDATION

Background and Structure

Founded in 1986 by a group of professional appraisal organizations involved with
real estate, personal property, and businesses.

Congress established an appraisal subcommittee to monitor and recommend federal
financing for foundation activities related to real estate.

Funded by member organizations, Congress, and donations.

Governed by a board of trustees of approximately 32 members.

Two advisory councils:

The Appraisal Foundation Advisory Council (TAFAC)-composed of non-profit
organizations and government agencies.

Industry Advisory Council (IAC)-composed of for-profit organizations such
as independent appraisal firms, certified public accountant (CPA) firms, and
lenders.

Appoints members to two independent boards:

Appraisal Standards Board (ASB)-issues Uniform Standards of Professional
Appraisal Practice
(USPAP), updated annually in November.

Appraiser Qualifications Board (AQB)-sets qualifications for appraisers (has
set qualifications for real estate appraisers; working on qualification criteria for
personal property appraisers; as of 2002, no plans to set criteria for business appraiser
qualifications).


Uniform Standards of Professional Appraisal Practice (USPAP)

Exhibit 2.1 is the table of contents for USPAP '02.

Compliance with USPAP is legally mandatory for all real estate transactions of
more than $250,000 involving federally related agencies and for conversions of
mutual savings and loans to stock companies.

Sections of USPAP that are most directly applicable to appraisers of businesses
and intangible assets:

Prefatory material (preamble, ethics provision, competency provision, departure
provision, jurisdictional exceptions, supplemental standards, and definitions),
which applies to appraisals of all types of property.

Standard 9, which includes procedural requirements for appraising a business,
business interest, or intangible property.

Standard 10, which includes requirements for reporting an appraisal of a business,
business interest, or intangible property.

Business appraisers also should be familiar with USPAP standards for appraising
other types of property, because other property often is included as part of a
business.

The edition of USPAP that applies to any particular appraisal is the edition for the
year in which the appraisal is performed, not
the effective date of the appraisal in
the case of retrospective appraisals.


Major Provisions of USPAP Standards 9 and 10 (per USPAP '02)

Note: The following listing contains only the basic provisions. The provisions
also are supplemented by comments, and the appraiser should read and understand
the standards as a whole.


Standards Rule 9-1

In developing a business or intangible asset appraisal, an appraiser must:

(a) be aware of, understand, and correctly employ those recognized methods and
procedures that are necessary to produce a credible appraisal;

(b) not commit a substantial error of omission or commission that significantly affects
an appraisal; and

(c) not render appraisal services in a careless or negligent manner, such as by making
a series of errors that, although individually might not significantly affect the
results of an appraisal, in the aggregate affect the credibility of those results.

Continues...




Excerpted from Business Valuation Body of Knowledge: Exam Review and Professional Reference
by Shannon P. Pratt
Copyright © 2003 by Shannon P. Pratt.
Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

Preface.

Acknowledgments.

Listing of References and Reference Abbreviations.

PART I. BUSINESS VALUATION ENGAGEMENT ENVIRONMENT.

Chapter 1. Business Valuation Legal and Regulatory Environment.

Chapter 2. Business Valuation Professional Environment.

Chapter 3. Business Valuation Engagement.

Chapter 4. Litigation Service Engagements.

PART II. TERMINOLOGY AND NOTATION.

Chapter 5. International Glossary of Business Valuation Terms.

Chapter 6. Notation Systems Used in This Book.

PART III. VALUATION APPROACHES AND METHODS.

Chapter 7. Overview of Valuation Approaches and Methods.

Chapter 8. Income Approach: Cost of Capital.

Chapter 9. Income Approach: Discounting Method.

Chapter 10. Income Approach: Capitalization Method.

Chapter 11. Market Approach: Guideline Public Company Method.

Chapter 12. Market Approach: Guideline Merger and Acquisition Method.

Chapter 13. Prior Transactions, Offers, and Buy-Sell Agreements.

Chapter 14. Adjusted (Net) Asset  Method.

Chapter 15 . Excess Earnings Method.  

Chapter 16. Discounts and Premiums.

Chapter 17. Reconciliation and Value Conclusion.

PART IV. ANALYSIS OF THE COMPANY. 

Chapter 18. Financial Statement Analysis.

Chapter 19. Using Economic and Industry Data.

Chapter 20. Site Visits and Interviews.

PART V. SUPPORTING DATA.

Chapter 21. Sources of Supporting Data.

PART VI. SAMPLE CASE.

Chapter 22. Sample Case: Shannon's Bull Market.

PART VII. VALUATIONS FOR SPECIFIC PURPOSES.

Chapter 23. Tax-Related Valuations.

Chapter 24. Employee Stock Ownership Plans (ESOPs).

Chapter 25. Shareholder Buyouts and Disputes.

Chapter 26. Marital Dissolutions.

Appendix A: Bibliography of Reference Sources.

Appendix B: Federal Rule of Civil Procedure 26: General Provisions Governing Discovery; Duty of Disclosure.

Self-Study CPE Examination.

Index.

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