This article will cover on the premises of value that shall be considered while valuing an asset or a liability, as per the valuation standards issued by the Valuation Standard Board of the ICAI.
1. Meaning of premise of value:
The ICAI Valuation Standard -101 (IVS-101) defines premise of value to be the conditions and circumstances how an asset is deployed. It’s a kind of assumption or a statement regarding the most likely set of transactional circumstances that may be applicable to the subject valuation. In common parlance, premise of value refers to an assumption or a statement, based on which a study is undertaken.
2. Importance of premise of value:
As stated that the premise of value is a kind of assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation. Thus, the premise of value is a critical step for selecting the right approach to compute the fair value of any asset/liability. It’s the premise of value which helps the valuer to determine what approach he should use to compute the value of asset/liability.
3. Premise of value identified by IVS-102 :
The ICAI Valuation Standard -102 (IVS-102)
identifies some of the following common premise of value which are as under : –
a) Highest and Best Use (HABU)
b) Going Concern Value
c) As-is – where- is Value
d) Orderly Liquidation
e) Forced Transaction
4. Use of premise of value: A valuer may use either, or more than one, of the given below premises for the purposes of valuation depending on the circumstances : –
a. Highest and Best Use: The Highest and Best Use (HABU) is generally used for a non-financial asset. As per the premise, the value of an asset is the value when used by a market participant who puts the asset to its maximum use. It may or may not be the use by the current owner, or the intended use by the prospective buyer. However, the current use of an asset is presumed to be at its HABU, unless a market or other factor proves to the contrary. If the current use is not at its HABU, the value shall also consider the cost of conversion required to put the asset from its current position to its HABU.
The HABU of an asset should be the one that is physically possible, legally permissible and financially feasible. The value is determined based on the price that a market participant would be willing to pay to buy it who derives the maximum value, either on a standalone basis, or in combination with a group of assets or with assets and liabilities. Utility and Substitution of the asset determines the HABU of the asset. The price would depend on the utility that can be derived from the property as well as on the price at which an asset with the similar utility is sold. For e.g. a space is vacant and available for occupancy, either for residential or commercial purposes. It is generally understood that leasing for commercial purpose generates more revenue than for residential purpose. Hence, though, there may not be offers to take the space on lease for commercial use, the value based on HABU would consider the income that would be generated on a commercial lease.
Note: A non-financial asset refers to an asset that is not traded on the financial markets, and its value is derived from its physical characteristics rather than from contractual claims. Examples of non-financial assets include tangible assets, such as land, buildings, motor vehicles, and equipment, as well as intangible assets, such as patents, goodwill, and intellectual property
b. Going Concern Value: Going Concern Value is the value of an enterprise which is expected to continue its operations and not liquidates in the near future. The value apart from the tangible assets also includes intangible assets such as Goodwill due to the trained workforce, the presence of an operational plant, necessary licenses, marketing systems, procedures in place, etc.
c. As-is-where-is value: As-is-where-is value is represents the existing use of the This may or may not be an HABU of the asset. This may be used in a valuation for the purposes of Financial Reporting.
d. Orderly Liquidation : An orderly liquidation refers to the realisable value of an asset in the event of a liquidation after allowing appropriate marketing efforts and a reasonable period of time to market the asset on an as-is, where-is basis. What is a reasonable period of time may vary depending on the asset type, market conditions, etc.
e. Forced Transaction: Sometimes, an owner of the asset may be under a compulsion to sell the asset within a limited period of time, as a result of which, he may not fetch its true value. Thus, it refers to a transaction in which the seller is forced to sell an asset without adequate marketing efforts or reasonable period of time to market the asset. A marketing constraint is not a forced sale. Sale in an inactive market also cannot be construed as a forced transaction. The limitation should be on the time required for marketing the product and sell it at reasonable price. A typical example of a forced transaction would be an auction.
5. Conclusion: The premise of value shall reflect the facts and circumstances underlying the asset to be valued and the purpose of valuation. The premise will have an impact on the other factors of valuation such as Valuation bases, approaches, methodology, etc. The premise of value shall be mutually agreed by the valuer and the client and shall also be documented as part of the engagement letter.
Author Bio
