Valuation Concepts and Methods Chapter 6

VALUATION CONCEPTS
AND METHODS
ASSET-BASED VALUATION
METHOD
Objectives
 Define asset-based valuation
 Explain the roles and importance of asset-based
valuation
 Calculate asset values using asset-based
methodologies
INTRODUCTION
This lesson will discuss how investors will
determine how much they are willing to acquire
it. Since asset has been identified by the industry
as transactions that would yield future economic
benefits as a result of past transactions. Therefore,
the value of investment opportunities is highly
dependent on the value that the asset will
generate from now until the future.
WHAT IS ASSET VALUATION?
Asset-based valuation simply pertains to the
process to determine the value of a specific
property, including stocks, options, bonds,
buildings, machinery, or land, that is conducted
usually when a company or asset is to be sold,
insured, or taken over. The assets may be
categorized into tangible and intangible assets.
Valuations can be done on either an asset or a
liability, such as bonds issued by a company.
WHAT IS ASSET VALUATION?
Asset-based valuation focuses on the value of a company’s assets or
the fair market value of its total assets after deducting liabilities.
Assets are evaluated, and the fair market value is obtained.
For example, landowners may collaborate with appraisers to work

out a property’s market worth. Over time, property values increase,
and a proprietor may realize a piece of property is worth more today
than it was five years ago. The new value is quoted and is used in the
asset-based approach. On the other hand, liabilities often occur at
true market value. Usually, no further calculations are done. Asset
valuation determines the cost of recreating a similar business.
The value placed on the assets is not fixed and can fluctuate as the
company buys and sells new assets.
IMPORTANCE OF ASSET VALUATION
Asset valuation plays a key role in finance and

consists of subjective and objective measurements.
The value of a company’s capital assets is
straightforward to value, based on their book
values and replacement costs. The value can easily
be ascertained on tangible assets. However, there is
no figure on the financial statements that tell
investors exactly how much intangible assets are
worth. Companies can overvalue goodwill in an
acquisition as the valuation of intangible assets is
subjective and can be difficult to measure.
There are many reasons for valuing assets, including the following:
1. Right Price
Asset valuation helps identify the right price for an asset,
especially when it is offered to be bought or sold. It is beneficial to
both the buyer and the seller because the former won’t mistakenly
overpay for the asset, nor will the latter erroneously accept a
discounted price to sell the asset.
2. Company Merger
In the event that two companies are merging, or if a company is to
be taken over, asset valuation is important because it helps both
parties determine the true value of the business.
3. Loan Application
When a company applies for a loan, the bank or financial
institution may require collateral as protection against
possible debt default. Asset valuation is needed for the
lender to determine whether the loan amount is covered by
the assets as collateral.
4. Audit
All public companies are regulated, which means they
need to present audited financial statements for
transparency. Part of the audit process involves verifying
the value of assets.
WHEN IS THE ASSET-BASED
VALUATION APPROACH USED?
The asset-based valuation approach is the generally accepted method for
valuing a company. An analyst looks at four factors when valuing a
business:
1. Type of company
With regard to the type of company, the asset-based approach can be used
by companies that own both tangible and intangible assets. Therefore, the
valuation can be used for asset holding companies and asset operating
companies. Virtually all businesses fall into one of these two categories.
2. The company’s business interests

Business interests can also affect valuation. The asset-based approach is used
to value the overall business and is usually performed during the purchase
or sale of the business, or a merger or acquisition. It is also used when the
price of the business is directly related to its tangible and intangible assets
and not the value of its stock.
WHEN IS THE ASSET-BASED
VALUATION APPROACH USED?
3. Types of transactions in the business
The asset-based valuation method is used for taxable
transactions to secure financing, as various creditors
place a different value on the assets of the business.
4. Availability of data
Lastly, the amount of information available can also
affect an analyst’s ability to use this valuation approach.
If there is no access to asset-specific information or if
there’s been a substantial change(s) in the value of
tangible or intangible assets since their valuation date, it
can impede the analyst’s ability to use the method.
METHODS OF ASSET VALUATION
1. Cost Method
The cost method is the easiest way of asset valuation. It is done by
basing the value on the historical price for which the asset was
bought.
On January 1, 2019, Bebe Co. acquired four heavy-duty computer laptops

from Picky Co. amounting to Php175,000. Bebe Co. paid Picky Co. cash
equivalent to 10% of the cost and issued a 7% promissory note for the
balance. Using the cost method, what amount of computer equipment
should be recorded in the books of Bebe Co.? Answer: Php700,000
On March 1, 2021, Bebe Co. sold one of its laptop to Mi’bagona Co. at cost.
What is the journal entry for the transaction?
Answer: Debit: Cash-Php175,000; Credit: Equipment-Php175,000

2. Market Value Method
The market value method bases the value of the asset on
its prevailing market price or its projected price when
sold in the open market. In the absence of similar assets in
the open market, the replacement value method or the net
realizable value method is used.
On May 17, 2021, ABC Co. acquired a commercial lot from

Lupain Inc. with a historical cost of Php1,000,000 and a fair
market value of P1,500,000. On the date of sale, how much
should recorded as gain or loss on sale?
Answer: Php500,000 gain

3. Base Stock Method

The base stock method requires a company to
keep a certain level of stocks whose value is
assessed based on the value of a base stock. The
base stock method is a valuation technique for the
inventory asset, where the minimum amount of
inventory needed to maintain operations is
recorded at its acquisition cost, while the LIFO
method is applied to all additional inventory. This
approach is not acceptable under generally
accepted accounting principles.
4. Standard Cost Method
The standard cost method uses expected costs instead of actual costs,
often based on the company’s past experience. The costs are obtained
by recording differences between expected and actual costs.
Example:
Levis Inc. purchases its denim from a local supplier with terms of
n/30, FOB destination. This means that ownership of the denim
passes from the supplier to Levis when Levis received the materials.
When denim arrives, Levis will record the denim received in its
Direct Materials Inventory account at a standard cost of Php3.00 per
yard and will record the liability at the actual cost for the amount
received. Any difference between the standard cost of the material
and the actual cost of the material received is recorded as a purchase
price variance.
Illustration 1:
Assuming that on January 2, 2019 Levis ordered 1,000
yards of denim at Php2.90 per yard. On January 8, 2019,
Levis received the item. The journal entry would be:

01/08/2019 Direct Materials Inventory 3,000
Accounts Payable 2,900
Direct Materials Price Variance 100

In this case, it shows that the company is experiencing
actual costs that are favourable than the planned,
standard cost.
Illustration 2:
In February 4, Levis ordered 3,000 yards of denim at Php3.05 per yard.
On March 1, 2019, Levis received the item. The journal entry would be
03/01/2019 Direct Materials Inventor 9,000

Direct Materials Price Variance 150
Accounts Payable 9,150
To Post the entries in the Direct Materials price variance:
Direct Materials Price Variance
03/01 150 100 01/08
03/01 50
A debit balance in a variance account is always unfavourable. It

shows that the total of actual cost is higher than the total of the
expected standard cost.
Thank You!

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VALUATION CONCEPTS

For example, landowners may collaborate with appraisers to work

Asset valuation plays a key role in finance and

2. The company’s business interests

On January 1, 2019, Bebe Co. acquired four heavy-duty computer laptops

Answer: Debit: Cash-Php175,000; Credit: Equipment-Php175,000

On May 17, 2021, ABC Co. acquired a commercial lot from

Answer: Php500,000 gain

3. Base Stock Method

03/01/2019 Direct Materials Inventor 9,000

A debit balance in a variance account is always unfavourable. It

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