The executive director of supervision at the Financial Reporting Council (FRC) (David Rule) completed a year-end review of the audit quality reviews conducted from 2018 to 2020 and found that the culture and methodology of audit, primarily at the Big Four firms, had improved measurably. ‘We have been encouraged by the initiatives that some firms are taking to develop and embed a culture of challenge’ to management, FRC concluded in their summary letter from Rule.

Of note to the business valuation profession in the UK, the FRC found that auditors ‘often struggle to challenge the management of audited entities effectively,’ citing judgements related to familiar business valuation analyses: ‘long-term contracts, goodwill impairment or the valuation of financial instruments.’

The FRC’s analysis reports that ineffective challenge of management was a driver in more than 80% of the audit files reviewed from 2018 to 2020 that had a less-than-satisfactory result.

‘Effective challenge of management is one of the most critical responses for the auditor in order to demonstrate that it has exercised appropriate professional scepticism, as required under a number of International Standards on Auditing (ISAs), particularly ISAs 200 and 540,’ the FRC states.

The FRC has stated that its AQR team will continue to focus on carrying out a thematic review on how firms support effective challenge of management and encourage a culture of challenge and robust professional scepticism.

The FRC’s conclusions about why valuation assumptions can go wrong during the audit process won’t surprise BVWire—UK readers. The report mentions three familiar problems:

• Insufficient use of internal specialists or experts;

• Issues relating to completeness of evidence, including too much focus on gathering corroborative evidence and not being sufficiently alert to contradictory evidence; and

• Overreliance on management inquiry.

These initiatives are consistent with a renewed focus by the FRC on audit quality. In 2019, the FRC revised its ethical standard and its auditing standards in order to support the delivery of high-quality audits in the UK, with the stated intention of strengthening auditor independence and reducing the risk of conflicts of interest.

The FRC’s analysis targets the big audit firms, but it clearly states that valuation expertise is being underused as a necessary step to improve audit quality and judgements.

One independent UK business valuer commented that auditors often overlook the professional standards for the valuation profession as they try to comply with changing audit standards. ‘I don’t do valuations to follow audit policy. I do them to follow finance and economic principles, and I’m not sure the auditors remember this fact when I’m hired to provide an outside analysis,’ she told BVWire—UK.

Relatively few UK business owners understand what a business valuation does—and how they could benefit from the process. BVWire—UK notes that many owners, in fact, harbour misperceptions about the entire process.

Plimsoll, the data and industry research company, also offers a valuation service that they promote directly to business owners. Their business development efforts offer a good model for all business valuation experts trying to promote their own practise.

Some of Plimsoll’s promotional themes include:

• Make business valuation an annual checkup to see whether your business has, ultimately, increased in value. ‘Having your business valued should be like the MOT you get on your car or the blood pressure check you have at your doctor’s surgery,’ Plimsoll says.

• Recognise that current volatility makes valuation even more critical. ‘In these increasingly uncertain times, an annual business valuation should form part of your strategic planning each year.’

• Preparing financial accounts is procedural. Business valuation is forward-looking. ‘Why not take that mundane requirement and turn it into insightful, strategic exercise that adds value throughout the trading year?’ Plimsoll asks business owners.

Annual business valuations offer very specific and timely benefits, the firm argues. These annual checkups:

• Allow owners to set an annual benchmark and adjust their strategy;

• Provide the first step in succession planning;

• Help shareholder communications and keep them invested in the business’s prospects (and placate shareholders who are worried that COVID-19 has ravaged their net worth);

• Provide a basis for easier dispute resolution, when relationships sour, since both sides start from a common understanding; and

• Offer an inexpensive independent comparison to benchmark companies.

The business valuation profession in the UK is not well understood, so BVWire—UK applauds this kind of promotional activity to increase awareness. Not all clients will want an annual valuation, but perhaps they should.

RICS have been in the news the last few weeks regarding the termination of directors and whistleblowing activities—but they’ve also released a draft of a revised international glossary of business valuation terms. The new International Valuation Glossary—Business Valuation has been developed in collaboration between RICS and various other international valuation professional organizations (ASA and AICPA in the US, TAQEEM in Saudi Arabia, and CBV Institute in Canada). Public comments on the draft are due 31 January.

While the new draft nearly doubles the number of defined terms that appeared in the original version, the new technical definitions and methodologies won’t offer a lot of surprises to business valuation experts.

However, some practitioners we spoke with are worried that RICS’ intent to include these as part of their valuation standards could expose experts to further challenges during litigation or other contested situations. One UK valuation expert said he expects to be asked about why, or why not, he used various methods that are now defined in the new glossary. ‘If you answer “no,” the next question you’ll get is “Why not? It’s in your professional standards.”’

For this reason, it may be better for RICS to promulgate the revised glossary in a ‘nonauthoritative’ form, such as an advisory or practice aid.

Some of the new financial terms defined in the draft include:

• Backsolve method;

• Cost savings method;

• Current value method;

• Distributor method;

• Greenfield method;

• Hybrid method;

• Investment method;

• Premium profits method;

• Summation method; and

• With and without method.

In addition to new methods, the proposed revised glossary adds technical terms including ‘All Risks Yield,’ ‘Calibration,’ ‘En Bloc Value,’ ‘Evidential Skepticism’ (that differs from ‘Professional Skepticism’ in the document), ‘Notional Market Valuation,’ ‘Ratable Value,’ ‘Self-Skepticism,’ and ‘Sustainability’ (that relates to climate change, corporate responsibility, and other factors).

In December 2018, the IVSC constituted a new Financial Instruments Board, tasked with reviewing and improving IVS 500: Financial Instruments. That board—which brings together senior representatives from global banks and other institutions, regulators, auditors, analysts, and others—has now concluded the first of two phases of a proposed new standard, resulting in the publication of this Exposure Draft. The IVSC request that comments be received by 19 April, so that the Exposure Draft is fully informed by those that commission, prepare, review, and ultimately use valuation information. Download the Financial Instruments Exposure Draft and access the online feedback form.

Deloitte’s latest CFO survey for Q4 2020 should provide an emotional lift for all business leaders and valuers—even though the survey was conducted the week before the new COVID-19 restrictions were announced on 19 December and the Brexit deal on 24 December.

Deloitte reports that these finance leaders expect a return to growth in 2021 with optimism rising to a record high—though most do not expect their own businesses to recover to prepandemic levels until the last quarter of 2021 or later.

Surprising key forecast findings include:

• CFOs’ optimism rating in the new survey achieved a 12-year high. In fact, 71% expect their revenues to rise over the next 12 months, up from 29% in Q3 2020.

• These financial leaders see the Brexit trade deal, which came after the survey closed, as a positive, at least compared to the impact of the no-deal alternative, which was reviewed as a significant risk to the economy.

• Brexit is viewed as having far less impact on CFOs’ own businesses than the economy as a whole.

• Half of CFOs think it will take until the last quarter of 2021 or later for their own revenues to return to prepandemic levels.

• Finance leaders expect levels of home-working to rise fivefold by 2025 compared to prepandemic levels and forecast higher levels of taxation and regulation in the longer term.

• CFOs still feel cautious about significant investment. Only 19% believe it is a good time to take greater risk onto the balance sheet. Deloitte notes this is up from just 3% in Q1 2020.

This is the 54th quarterly survey of chief financial officers and group finance directors of major companies in the UK.

ICAEW Advanced Valuation Techniques,17-18 February or 14-15 June, virtual classroom taught live by Steve Shaw

Catching the SPAC Wave: M&A Activity and SPAC-Related Litigation, 28 January, Vinson & Elkins webinar

Want to share a news item? Have feedback or comments? Please contact
David Foster at ukeditor@bvresources.com.