Question

There are three valuation methods that reflect historical values: acquisition cost, adjusted acquisition cost, and present value of cash flows using historical interest rates. For each of three methods discuss what the valuation represents and provide an example of a balance sheet item that is valued using the method. In addition, for each of the three methods valuation methods explain its advantages and disadvantages.

Answer 1

Ans) The three methods are 1. Acquisition cost

2. Adjusted acquisition cost

3. Present value of cash flows using historical interest rate.

1.) Acquisition cost valuation method : In this method the cost of Assets are taken from the financial statements as the the price paid at the time of purchase or historical cost. The acquisition cost is the cost incurred to take a business or a company based on the historical value of assets. In this method a comprehensive valuation is done for a company basis the  financial statement and the cost of assets are evaluated. A comprehensive report is filed and beyond asset payment other payments are made like legal fees and commisions etc.The asstes can be tangible or intangible which includes land and building and goodwill etc. Advantage is it is simple and reliable the disadvantage is there can be a scope for manupulation.

2. )Adjusted -aquisition cost: In Adjusted aquisition cost method as the name suggest ,includes for the purpose of valuation the historic cost of asssts minus any provition such provision for depreciation in case of tangible assets and amortisation in case of intangible assets.On the basis of the above mentioned adjustment the cost of the assets are calculated of a company to be acquired here the advantage is related to it is simple and as the depreciation provision and amortisation is calculated as per the accounting norms it is reliable.On the other hand there is a great deal of subjectivity involved in calculation of the depreciation provision. Balance sheet item involved equipment and machinery.

3.) Present value of cash inflows using historical interest rate involved finding the value of the business to be acquired taking into account the cash inflows as well as outflows generated to have a fair value of a company. The acquiring company on the going concern basis consider that the company will continue to be operated and establish a direct relation between the current flow and future income. The cash flows are discounted on the basis of the interest rate that is there at the time of initial transactions the balance sheet items are Bills payable or notes payable or bill receivable or note receivable. The advantage is it is not tedious and realistic as the earning capacity of the business is correctly evaluated the main disadvantage is it depends upon the personal view in determining the historical interest rate.