Author Terri Lastovka, CPA, JD, ASA, ARM
Abstract: Appraisal review is often used to assess the creditability of an appraisal report. This article discusses how to use the factors of USPAP Rule 3-3 to develop and report an appraisal review assignment, particularly in litigation situations.
Appraisal Review is frequently thought of as testing for compliance to USPAP or some other professional appraisal standard such as SSARS,[i] NACVA,[ii] or IVS.[iii] But when working in the litigation arena, we frequently find ourselves up against an expert report that is prepared by someone without any appraisal credentials; and therefore, no standards to be applied (or reviewed against). Now what?
An expert’s role in court is to assist the trier of fact – that is the judge or magistrate. It is our job to assist the hearing officer as to the creditability of an appraisal report. So, what are we looking for?
[i] Statements on Standards for Accounting and Review Services issued by the accounting and review services committee of the American Institute of Certified Public Accountants (AICPA)
[ii]Professional Standards of the National Association of Certified Valuators and Analysts (NACVA)
[iii] International Valuation Standards set by the International Valuation Standards Council (IVSC)
The five factors of CAARR are the essence of USPAP Rule 3-3. A report that does not meet these five criteria is a report whose creditability is questionable.
Even if there are no applicable standards to assess, CAARR is essential to assist the trier of fact as to the report’s creditability and reliability. Let’s take a look at some examples.
I was asked by a friend to look over an appraisal he did, as he wanted a second set of eyes on it before submitting to the attorney. This appraisal was being performed for a divorce matter. The business subject to the appraisal bought furniture in North Carolina to sell in Ohio parking lots. If you’ve ever been to the Midwest in the winter, you quickly realize that this is a seasonal business operating only from spring through fall.
Upon initial review, I immediately noticed that the revenues spiked considerably in the most recent year. As it turns out, although the appraiser had several years of financial records to work with, the most recent year was only for the months of May through October. Rather than obtain the full twelve months, the partial year was averaged to calculate to a full year. This averaging shortcut—which ignored the seasonality of the business—caused the revenue of the most recent year to be 3 times higher than any of the previous years, thereby causing a significant overstatement of earnings, which in turn caused a significant overstatement in the concluded value.
Be cautious to not let the fee or your time constraints dictate the scope of work. Take the time to get what you need and be fully thoughtful of the work you are doing.
Be cautious of mathematical and formula errors. Have someone check your calculations. The courtroom is not the place you want to be when you find out that something is wrong with a formula in your excel spreadsheet. This can happen easily when you have a case drag on or discovery comes in piecemeal. Say for example that you initially get financial statements for 2018-2021 and do your thing. But the case drags on. Now a year later you are asked to update your analysis with 2022 data. So, you add one more column to account for the additional year. Don’t forget to go back and check ALL your formulas to account for new columns and new lines in your spreadsheets.
Regardless of budget, do not shortcut your research. A personal property appraiser with 20 years of experience valued residential contents for use in an estate tax filing. One of those items was a table he valued at $3,000 and ultimately sold at auction for $1,650. However, only 12 days later, that same table sold for $1.37 million. How did this happen? The appraiser/auctioneer based his value opinion on his personal experience rather than researching evidence to support his opinion. Shortcuts can cause significant oversights, which can lead to very unpleasant lawsuits against the appraiser.
Are your facts straight? Do you know the applicable and relevant law for the matter at hand? In my state, the Standard of Value for divorce is Fair Market Value. And as we know, that means the price that a hypothetical willing seller will accept and a hypothetical willing buyer will pay, with all parties having knowledge of all relevant facts, and neither party being under any compulsion to buy or sell. One report I saw recently for a divorce stated that Mr. X wants to continue to do business as usual so there will be no goodwill to sell; only furniture, fixtures, and equipment is all that he is willing to sell. Let’s not overlook the very important word “hypothetical” and phrase “neither party being under any compulsion …”
This same report failed the adequacy factor where it stated “unrecorded cash sales – none of those numbers are applicable to valuing a business.” We are not IRS auditors, but we as appraisers have an obligation to ourselves, our profession, and our clients to include all relevant data. Exclusion of relevant data is certain to derive an illogical and incorrect conclusion. This report went on to say “In 41 years of business brokerage, my company never takes into account numbers that are not on the tax return.” Of course unrecorded revenues are applicable. Sounds a little ipsi dixit[i] to me; with a touch of competency issues.
[i] Law.com, Legal Terms and Definitions, accessed May 2, 2023: Ipse dixit is Latin for "he himself said it," meaning the only proof we have of the fact is that this person said it. https://dictionary.law.com/Default.aspx?selected=1027
A conclusion may appear reasonable on the surface, but look further. Normalizing adjustments to the income statement are made mid-stream to arrive at the final conclusion. Are the “normalizing adjustments” reasonable? For example:
Does it really make sense to adjust compensation for an owner who works full time to $100,000 based on some survey when the field supervisor who is not related to the owner’s family earns $130,000? Look at what the respective individuals actually do, what their responsibilities are, and how many hours are actually worked.
Does it really make sense to adjust marketing and advertising one year to be consistent with previous years? Look at the details to see where those dollars were spent and why.
Does it really make sense to adjust employee benefits to remove the baby gifts and holiday turkeys to the employees? Employees value more than just paychecks. Employees want to feel like they are valued by the employer. If this is a longstanding practice and not discriminatory, leave it be. The term “discretionary” can sometimes be taken to an interesting level.
Or do you think some of these adjustments were made to accommodate someone’s agenda? There is no room for agendas or advocacy in appraisal work.
Also be careful of blanket statements like “The business is worth nothing because it is not profitable.” Jumping to this conclusion without sufficient evidence can easily get your analysis, report, and conclusion thrown out of court, causing significant damage to your professional reputation. A simple search on DealStats shows 9,150 transactions where the Target reported operating losses. Of those, 632 reported negative seller’s discretionary earnings. If that blanket statement were always true, how could all of these transactions have happened?
Yes, CAARR is part of USPAP Standard 3.3. However, even if the Work Under Review is not subject to USPAP or any other stated standards, these five concepts are essential for a defensible appraisal and are useful to appraisal review professionals to assess the credibility of any appraisal work under review.
Terri Lastovka, CPA, JD, ASA, ARM, owner of Valuation & Litigation Consulting, LLC in Cleveland, Ohio is an Accredited Senior Appraiser along with being accredited in Appraisal Review & Management with the American Society of Appraisers, and is also a Certified Public Accountant and an Attorney. Terri has more than 30 years of experience consulting in the areas of business valuation, litigation consulting, business practices, financial considerations, and tax issues. Email lastovka@valueohio.com
[1] Statements on Standards for Accounting and Review Services issued by the accounting and review services committee of the American Institute of Certified Public Accountants (AICPA)
[1]Professional Standards of the National Association of Certified Valuators and Analysts (NACVA)
[1] International Valuation Standards set by the International Valuation Standards Council (IVSC)
[1] Law.com, Legal Terms and Definitions, accessed May 2, 2023: Ipse dixit is Latin for "he himself said it," meaning the only proof we have of the fact is that this person said it. https://dictionary.law.com/Default.aspx?selected=1027